If you are entering into a commercial lease as a tenant for the first time, you may be surprised to find that it differs from a residential lease in a number of key areas, and because a commercial lease forms an important part of a business it is crucial that you ensure you understand what it covers and how your operations may be affected if the terms are not negotiated fairly.
Here are some of the main components of a commercial lease.
Two of the most important parts of a commercial lease are how much a tenant will pay for use of the premises and when rent reviews will occur. Typically, rent reviews are performed annually, however, a tenant can negotiate with the landlord for them to be less frequent.
Rent reviews are most commonly calculated using one of the following methods:
- market rent;
- fixed percentage increase;
- fixed amount; or
- consumer price index (CPI).
Duration (or term) of the lease
The term of the lease is important because too short a period could mean a tenant is spending money moving, updating their client base, and refitting other premises, but too long of an initial term could see a tenant losing leverage to negotiate if market conditions change.
A tenant should consider what duration is financially and commercially viable for their particular business before agreeing to a term and other factors such as upcoming developments in the area and whether construction could affect their business.
Options to renew
Most tenants want to operate from premises for enough time to ensure they can build up a client base and save on the costs and efforts associated with moving. A tenant should make sure the commercial lease they are entering into contains options to renew so that they are able to trade from the same premises after the completion of the initial term.
A tenant’s commercial lease should include information on exercising any option(s), such as how and when you must do so. The period to exercise any option(s) may also be affected by the legislation. If a tenant fails to exercise an option during the appropriate period, they risk not having the lease renewed by the landlord.
A ‘permitted use’ clause is usually included in a commercial lease. This clause outlines what the tenant is permitted to use the premises for, often including what goods and services a tenant are allowed to sell and provide. If the permitted use clause is not broad enough it may limit the type of business activities the tenant undertakes, and it may also limit their opportunities to sell the business or sublet the premises if they need to vacate early.
In most cases, commercial tenants will want to fit out their premises in a way that suits their business function, aesthetic, or both. Part of the commercial lease negotiations will be agreeing on installing or changing existing elements of the premises such as the paint or wall coverings, flooring, fixtures and fittings, and the shop front.
Sometimes tenants are able to negotiate for the landlord to pay for all or part of the fit-out, or to have their rent waived for the period it takes to fit out the premises.
Maintenance and repairs
A commercial lease should outline who is responsible for maintenance and repairs on the property. Typically, the tenant will be responsible for maintenance and repairs on the internal surfaces such as flooring, or fixtures provided by the landlord and any fixtures or installations made by the tenant themselves. The landlord would usually be responsible for any structural or major repairs related to the exterior of the building, including the roof and air conditioning.
It is a good idea to have the premises inspected by an independent third party prior to entering into the lease. The inspector can prepare a condition report, including photographs of the premises, for both the tenant and the landlord to accept. If a dispute as to the condition arises at the end of the lease, this report can be relied upon to determine what is wear and tear and what is genuine damage or negligence.
What clauses should I watch out for?
A tenant should be vigilant when checking the lease for an early termination clause, including a redevelopment clause a landlord may insist on. Terminating the lease before a tenant is ready can be costly to their business and interrupt operations.
It may also be a requirement of the lease that a tenant takes out building or public liability insurance. If this is the case, the tenant should ensure there aren’t any indemnity clauses in the lease that mean you are required to compensate the landlord in the event of any loss or damage in breach of any insurance policies.
Default or breach clauses are included in commercial leases to protect landlords against tenants who fail to pay their rent on time not keeping up with maintenance and repairs. The tenant should be aware of the terms and penalties for defaulting on or breaching a lease.
Depending on the tenant’s business, they may want to ensure other clauses are included in the lease. For example, if they are opening a shop within a shopping centre, an ‘exclusivity of trade’ clause may be introduced to protect their business from direct competition. This clause may entitle them to be the only business selling a particular product or service within the centre.
A commercial lease is far more involved than a residential lease and, it is strongly recommended that you seek legal advice before entering into a commercial lease. If you require assistance negotiating the terms of a commercial lease, our commercial lawyers can help.
The content of this blog is general; professional advice should be sought about specific circumstances. If you would like to talk to one of our experienced commercial lawyers on (07) 40520 700.