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What Are the Rules Behind Commercial Rent Reviews?

What Are the Rules Behind Commercial Rent Reviews?

Commercial rent reviews can take several forms. Find out what the options are and what is best for your circumstances.

26th March 2021
Reading Time: 4 minutes

What Is a Rent Review?

Simply put the price of rent is changed usually to align with costs and the average amount paid in the market. The general trend for commercial rent reviews is for rent to increase, however this is not always the case. Rent is usually altered through these methods:

  1. Comparison to the market.
  2. Adjustment to the Consumer Price Index (CPI).
  3. Fixed percentage increase.

Courts view businesses that entering into commercial leases as on par in negotiations. Because of this they will honour the majority of rent review arrangements. When reading your lease prior to signing, make sure you will be able to afford and plan for any increase to rent over the term of your lease and a renewal period. If it is not commercially viable, negotiate or it may be better to look elsewhere.

What Kind of Lease Do I Have?

Commercial leases are made for a specific business purpose. This is different to residential leases which have their own set of rules because someone will live in the property on a domestic basis. Retail leases are a kind of commercial lease with their own extra set of rules. It’s important to remember that commercial leases have less legal protection associated with them as the law assumes business people are more informed than consumers and lay people. Find out more about the difference between commercial and retail leases.

When Do Commercial Rent Reviews Happen?

Commercial leases are not subject to any frequency restrictions for rent reviews. The schedule will be specified in the lease agreement. Review usually occurs once every 12 months on the anniversary of the lease. 6 monthly and quarterly reviews are also common. In reality any frequency can be agreed to and depends largely on what the adjustment will be based on.

Market Rent

Adjustments to rent are made inline with the rate charged for similar properties, in similar locations at that point in time. The landlord will usually propose a price the rent should be going forward. When accepted by the tenant, this amount is deemed the value of market rent for the property.

If the tenant does not accept the proposal the amount can be negotiated. If there is disagreement, a market review can be organised by an independent valuer. When figuring out what the market rate may be an independent real estate agent or property valuer may be the kind of person to use. This can be an expensive exercise that may be charged to the tenant depending on the terms of the lease.

If the initial offer seems fair, is inline with your own expectations and research on the current market it may be wise to accept the initial offer. Market rent reviews can be main form of review but commonly are at specific times. Usually when there is a need to reassess what market rent is, for instance when a lease is renewed.

Percentage Rent

This can be in two forms.

A fixed percentage rental increase is where rent increases at a rate usually between 2% and 5% of the current amount paid. This provides certainty and predictability for both landlord and tenant in income and costs. Fixed percentage increases are commonly annual to quarterly depending on the location, market and negotiations of the parties to the lease. 

Rent reviews based on a percentage of turnover mean that you will pay a base rate of rent and an additional percentage on top once your business turner reaches a certain amount. Providing turnover details is a requirement under this kind of rent review. Many shopping centres include provisions such as these in their lease agreements for retail leases. Find out more about Turnover Rent.

CPI Adjustments

The adjustment to the value of rent can be based on the current CPI rate. This is published regularly by the Australian Bureau of Statstics.

The logic behind this form of rent review is that what you can buy for a certain amount of money will decrease as inflation increases over time. Adjusting to the CPI means that the landlord is getting the equivalent value in rent that they were in previous years. When inflation is increasing the amount of rent will increase. When inflation decreases, the amount of rent will also fall. Landlords will usually avoid this kind of review in times of economic downturn.

The terms of commercial rent reviews can combine CPI and fixed percentage increases to account for this. For example rent can be adjusted to the CPI + 2.5%, or set out in terms of whatever is higher; the CPI or 4%.

Rent Abatement

An abatement is a discount applied to the rent payable under the lease. The rent is set, then the discount applied. The are used as an incentive to attract tenants or encourage certain behaviour. Find out more on Rent Abatement.

Ratchet Clauses

On review clauses with this character prevent the rent value falling below the initial amount set when the lease began. They are illegal in residential and retail leases but are legal in commercial leases. In commercial leases it is up to the tenant to negotiate clauses like this out of the agreement prior to entering into it. Find out more about ratchet clauses here.

Registering the Variation

Most commercial leases are registered in order to be more easily enforceable, particularly by the tenant. Under the Real Property Act, a registered variation that increases or reduces the rent payable under a registered lease will not be valid or binding unless the registrar receives written consent to the changes from the proprietor affected (usually the landlord) before the changes have been registered.  

Finally

Because the terms of commercial leases are often longer than residential leases, it is important to get this right ahead of signing. Otherwise you may find yourself with commitments that may lead to the closure of your business if you cannot meet them. Speaking with a commercial leasing lawyer can help ensure you know what you’re in for and negotiate the best outcome for your business.

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Author
Matthew Rupp

Matthew is a Legal Tech Intern at Lawpath working in the content team. He is in his final year at Macquarie University. He is focused on making legal information accessible and easy to understand. He is interested in IP law, environmental planning law and administrative law.