Commercial Lease Negotiation: Did You Know There Are 40+ Points To Negotiate?

July 13, 2022
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Commercial Real Estate

Author

Maxwell Vaughan
Maxwell Vaughan
Director

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When it comes to commercial lease negotiation, there are some obvious factors that need to be hammered out, such as rent, lease duration, option to renew, permitted use and whether the space is able to be assigned or subleased.

However, what some tenants don’t know is that nearly all the terms in a commercial lease are negotiable. In fact, in a standard lease, there are over 40 points of negotiation that are often overlooked. And when seemingly small points are glossed over, they can become major problems down the line.

Here are 10 lesser-thought-of clauses to consider negotiating when it comes to your next office lease.

1. Land tax

Land tax is a State tax charged annually and fluctuates based on the value of a property. It's calculated on a single-holding basis or a multiple-holding basis (where the landlord owns more than one property).

Land tax is one of the most common costs that landlords seek to pass on to their tenants, and, in theory, they should be charging it on a single ownership basis. But some tenants run into issues where their leasing agreement fails to stipulate how the land tax will be payable (i.e. a single or multiple calculation), or where the contract stipulates single holding but the landlord charges on multiple holding.

So, when entering a lease negotiation, ensure that land tax ONLY applies to the property that you're leasing, rather than a combination of the landlord's properties. The difference in $$$ (i.e. statutory outgoings) can be colossal. And, when paying outgoings, a copy of the land tax invoice must be sighted to verify you're paying the right amount.

2. Effective market rent reviews vs. face market rent reviews

Most commercial leases with an option to review will include a market rent review clause. Here, the landlord will propose a new rental amount in line with what other tenants in the area are paying for comparable spaces.

But a critical and often misunderstood aspect of the rent review clause is whether the new rental is ‘face’ or ‘effective.’

Face rent is a figure that disregards incentives such as rent-free periods, rent reductions (a.k.a rent abatements) and fit-out contributions. In contrast, effective rent is a rental amount that the landlord receives after paying all expenses for operating the property, costs for tenant works and amortising incentives.

At Tenant CS, we strongly advise our clients to negotiate an effective rent review clause (i.e. factoring in all incentives) to ensure that the new rent that the landlord proposes is not subject to false inflation.

You can read more about the difference between face and effective market reviews here.

3. Market review period

When it comes to renewals, it's common for market rent to be reviewed six months after you have signed your new lease. In an ideal world, you want to know what the new market rent will be BEFORE you sign your lease.

So, negotiate the right to obtain a market review before the due date to exercise your option. That way, if there's likely be a substantial rental increase, you can decide against exercising your option and go to an open market instead. Alternatively, you could look at negotiating the right to terminate your lease if the review comes in at an unacceptable rate.

lady on the phone entering a commercial lease negotiation with her landlord

4. Market review notice dispute

Another element of the rent review process that can trip up tenants is when a tenant has to dispute a new rental amount. Here's how it works:

  1. The landlord provides a new rent notice based on an assessment of the market
  2. The lessee is then given some time (usually around 14 days) to agree with, or dispute, the new rental amount
  3. If the tenant agrees (OR if the tenant hasn't responded by the due date) to the proposed figure, it is taken as the new rental amount
  4. If the tenant contests, then the tenant and the landlord must negotiate until they can agree on a fair market rent.
  5. Once all parties agree to the amount, it is deemed to be the current market rent.

The problem here lies in the timing allowed for the above to take place. A tenant will often find that 14 days is not enough time to do their research and react quickly. And, if you respond too late, the new rent is deemed to be accepted.

5. Redecoration works and definition

Redecoration clauses are common in commercial leases. They require a tenant to carry out maintenance or upgrade works after a set number of years and are distinct from "make good" obligations.

The provision will usually highlight two things:

  1. the period for when the redecoration must take place (for example, at least once every five years)
  2. the specific work that the tenant will need to complete (e.g. repainting the walls, replacing carpet)

Failing to comply with the redecoration clause can result in financial penalties or termination of the lease. So, if it’s in the contract, it’s not negotiable.

But what tenants don't always realise is that they can negotiate the type of works required and how often they'll need to be carried out. (It's always better to negotiate terms that you know you can comply with rather than trying to resolve a dispute after signing your lease). It's also essential to get the wording right to avoid landlord-tenant conflict down the track.

6. Cleaning charges prior to occupation

Other costs, such as cleaning, also need to be considered in your commercial lease negotiation. These costs are additional to the rent and can be significant, particularly if the wording is ambiguous.

For instance, Tenants often get charged for cleaning charges during the period they are completing fit-out works and cleaning is not possible. However, it is possible to negotiate that the cleaning contract is put on hold while the premises are unoccupied.

As a tenant, it’s essential to clearly understand your responsibilities and be as specific as possible when it comes to the wording around additional costs.

7. Incentives

Commercial lease incentives are payments or concessions offered by a landlord to:

  • encourage a new tenant to sign a lease
  • entice an existing tenant to renew.

The most common types are rent-free periods, rent reductions and fit-out contributions.

But a tenant negotiating their own commercial lease incentive can be akin to asking Dr. Google for a diagnosis. Only those who are watching the markets can confidently tell you what current incentives should be. You need to be monitoring vacancy rates, property yields (cap rates), market rents and fair escalation rates to understand what incentive you can negotiate – and the difference can be in the $100’s of $1,000’s.

In any case, if you are negotiating your incentives yourself, be sure to:

  • Consider the kind of incentives that will work best for your business
  • Thoroughly research current market conditions
  • Understand the tax implications

Read more about commercial lease incentives in our Ultimate Guide To Commercial Lease Incentives, For Tenants.

8. Payment of legal costs

A common area of confusion is whether a tenant is liable for the landlord's legal fees. And the answer to this question is not always black and white; it depends on your lease terms.

A lot of the time, each party will be responsible for their own legal costs. But some landlords will try and get you to pay their legal costs, too. So, it's a good idea to ensure that the wording stipulates that each party pays its own legal fees. Or, at the very least, that the amount payable by you (the tenant) is capped.

Tenants should also avoid (or negotiate out of) any clauses that require them to pay the landlord's legal costs if there is a dispute within their lease term.

9. Green building scheme / Environmental ratings

Nowadays, many landlords include lease clauses that denote that any associated costs for Green Building Scheme initiatives or improvements are passed onto the tenants. While most tenants will welcome an energy-efficient and environmentally friendly building, these types of clauses open tenants up to unexpected costs.

So, it pays to agree with the landlord in advance regarding:

  • What these works could be
  • How these costs are passed on to you, the tenant (or at least agree to a capped amount).

10. Covid-friendly lease terms

When entering a commercial lease negotiation, be sure to negotiate clauses that protect you now and in the future. Specifically, think about:

  • Break clauses – which enable you to terminate the lease early and clauses to assign or sublease your space should market conditions change again
  • Lease flexibility – for example, the option to take more, or give up, office space
  • Act of God provision (aka Force Majeure) – try to get the words “epidemic,” “pandemic”, or “disease” included within an “act of God” or “force majeure” clause to ensure you’re covered in the future.
Image of two people shaking hands to represent commercial lease negotiation

The bottom line

The terms of your commercial lease can act like a slow leak in your tires and can open the door to unexpected costs.

What's more, it's a tenant's market. Covid has turned the world on its head and commercial real estate markets are feeling the impact. With every deal done, a new bar is set. And nowadays, anything is negotiable; the devil is in the detail.

So, critically evaluate your future needs, hit your commercial lease negotiation hard, and consider all opportunities before entering into an agreement.

Better yet, work with a tenant representative who will advocate on your behalf, ensure that your interests are protected, provide you with solid advice and break down confusing language. And, since most landlords cover the rep's fees, hiring one won't increase the cost of your search or negotiation.

Get in touch with the team at Tenant CS today to see how we can save you in your next commercial lease negotiation.

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