As a commercial tenant, entering into a new lease can be an exciting yet nerve-wracking experience. The terms of the lease agreement can have a considerable effect on the success of your business, so it’s crucial to understand each element of the agreement and negotiate the lease to suit your needs before signing on the dotted line.
1. What is the term of the lease?
Landlords generally prefer longer lease terms for their own peace of mind, but tenants should carefully consider the amount of time they wish to commit to.
For a new business, it would be prudent to negotiate a shorter initial term in case the business fails, so that the tenant’s risk is limited, to some extent, by the fact that they are not tied to a lease contract for a lengthy period of time.
On the other hand, an established business may wish to negotiate a longer term if operation from that particular site is appealing.
2. Are there any rights of renewal?
The right to renew the lease for further periods of time is a right that is exclusive to the tenant.
For example, rather than having a lease for a single term of 10 years, it would not be uncommon for that 10 years to be broken down into smaller periods, such as an initial term of two years followed by four further terms of two years each. Breaking the overall term of the lease into parts like this can be of great benefit to the tenant, as it provides security in the knowledge that they can remain at the premises for a long period of time, but having the flexibility to end the lease after the initial term or any of the renewal terms if they wish to do so.
Again, most landlords will prefer longer terms with fewer lease renewals rather than shorter terms with many renewals so that they have some security of tenure in their premises.
3. How often will the rent be reviewed?
The standard ADLS (Auckland District Law Society) form of lease that is most commonly used in New Zealand includes two options by which the rent payable by a tenant can be reviewed, from time to time. The rent can either be reviewed to a ‘market’ rate or to a rate that is equal to the increase in the CPI (consumers price index).
This is not to say that the parties cannot agree to review the rent in another manner. For example, it could be agreed at the commencement of the lease for the rent to increase by predetermined amounts on certain dates. Or, the landlord and tenant could agree for the rent to increase by an amount that is equal to the increase in the CPI plus a margin.
There are many factors that should be taken into account when considering what form of rent review is most appropriate to the tenant, including the physical location of the premises. Certain geographical locations may now, or in the future, be more likely to experience dramatic increases in market rents. As such, to minimise the effect that this may have on the tenant, it would be more preferable for the tenant to negotiate rent reviews that are fixed at a certain amount or fixed with reference to the CPI (which, at present, is hovering around a 1.5% to 1.9% increase annually, although this may change in time).
4. Is a guarantee required?
Most commercial landlords will require guarantees to be provided by a commercial tenant, although established, well-known tenants often manage to negotiate a lease without a guarantee.
Guarantees can take a number of forms, but the most common are:
- Personal guarantees from the director(s) and/or shareholder(s) of the tenant. If a director or shareholder is required to give a personal guarantee, their personal assets are put at risk if the company fails to meet its obligations under the lease. It is therefore up to the individual concerned to assess the potential risk they face if they were to agree to such security being given.
- Cash security bonds. A cash security bond is an amount paid to the landlord (or another stakeholder) by the tenant as security for the performance of the lease. The landlord would be able to draw upon the bond if the tenant was in breach of the lease. Ideally, if the tenant was to provide a cash security bond, they should not be required to also provide a personal guarantee.
- Bank guarantee. Essentially, the tenant’s bank agrees to pay the landlord a sum of money to remedy a breach of the lease from funds held by the bank. This will usually require the tenant to place money in an account with the bank, in order for the bank to be able to give this assurance to the landlord.
The benefit of opting for a cash bond or a bank guarantee is that the personal assets of the director(s) and/or shareholder(s) are not put at risk.
Tenants and potential guarantors should always look to limit the extent of any guarantees. For example, it could be agreed that if the tenant complies with the terms of the lease within a certain period of time, the landlord will release the guarantor from the personal guarantee, refund the cash bond or remove the requirement for a bank guarantee to be held.
5. What outgoings will you need to cover? And how will they be charged?
In addition to rent, commercial tenants are required to reimburse the landlord for certain expenses, including rates, insurance premiums and excesses and charges for water and rubbish collection.
Tenants should have a clear understanding of what it is they will be charged for. Ideally, the landlord would prepare a budget and provide it to the tenant on each anniversary of the lease commencement date.
Some landlords on-charge outgoings only when the charges are received, while others will charge an equal monthly amount ‘on account’ of outgoings, then invoice or provide a credit to offset any discrepancies at the end of each year. The latter process can be more beneficial for the tenant’s cash flow. Under no circumstances should landlords arrange for outgoings to be charged to tenants directly.
If the tenancy is in a unit titled property, contrary to common belief, the landlord is not able to recover all body corporate charges from the tenant, but instead only those parts of the charges relating to insurance premiums, valuation fees and management. All too often, we find that commercial tenants are being charged for the full amount of body corporate levies, which can include charges for long-term maintenance and contingency. These types of body corporate levies should certainly not be recovered from the tenant and are excluded from the standard terms of the ADLS lease.
6. Are photos showing the condition of the premises attached to the agreement?
The ADLS form of lease states that on the termination of the lease, the tenant must return the premises to the landlord in the same state of repair as it was at the commencement date (making an exception for ‘fair wear and tear’).
To prevent disputes arising between the landlord and tenant at the termination of the lease, we recommend that photos are taken of the premises before the lease’s commencement, particularly photos of any existing issues at the premises, such as cracks, damage and state of paint. These photos should be attached to the lease as evidence of the state of the premises.
We strongly encourage you to seek legal advice before signing a commercial lease agreement. If you would like to have your lease agreement reviewed or speak with us about a commercial tenancy, please get in touch with Andrew or contact reception.
This article is brief and general in nature. You should not treat this article as legal advice and should seek professional advice before taking any action in relation to the matters dealt with in this article. Armstrong Murray accepts no liability for losses suffered by any person or organisation who may rely directly or indirectly on this article.
