In Short
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- Market rent reviews adjust the rent to reflect current market conditions and are commonly performed at lease renewal or specified intervals.
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- Retail leases follow strict state laws, while commercial leases offer more landlord discretion.
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- Disputes over market rent may require a valuer, and tenants should understand clauses like ratchet provisions before signing.
Tips for Businesses
Before signing a lease, understand how market rent reviews will be handled, including the factors that will influence rent adjustments and any potential dispute resolution processes. Be cautious of ratchet clauses, which can prevent rent decreases, especially in commercial leases. Legal advice is essential to navigate these complexities effectively.
Conducting a market rent review in a lease document is not always straightforward. Many variations depend on how parties draft the document. This article explores the market rent review process in both retail and commercial leasing.
What is Market Rent Review?
A Market Rent Review allows the rental amount to be assessed and adjusted to prevailing market rates when the review is undertaken. The market rate is determined by several factors, including but not limited to:
- the rates for similar properties of the same types (e.g. office, retail, warehouse, industrial) with similar sizes, ages and amenities;
- the location of the property;
- the condition of the property; and
- shifting market demand.
Still, your lease agreement may contain other rent review methods. For example, a tenant and landlord may agree on a certain rental amount, or the rent may increase by the consumer price index (CPI) or a fixed percentage rate.
How Do You Determine Market Rent?
The process for determining market rent can differ depending on whether the lease is a retail or a commercial one.
State-based legislation governs retail leases. Each state and territory law will strictly prescribe the procedure for how parties should conduct a market rent review.
However, very few legislation protect commercial tenants and even fewer for other non-retail tenants. Although the market rent review process may be similar across all leasing agreements, the landlord under a non-retail lease has greater discretion to determine the process and what factors they might take into account.
Continue reading this article below the formRetail Leases
Generally, in each retail legislation, ‘current market rent’ is the rent a landlord would reasonably expect a tenant to pay in an arm’s length transaction if the shop was currently unoccupied and offered for rent.
A landlord must typically advise tenants of their proposed market rent within a stated time frame. Accordingly, the tenant can either accept, reject or counter the amount.
If a landlord and tenant cannot agree on the current market rent, the next step is appointing an independent specialist retail valuer. This is generally appointed by agreement between the landlord and tenant. Both parties would equally bear the valuer’s costs. If the parties cannot agree on a valuer, either party can make a request to the Registrar or Small Business Commission (depending on the state legislation). Depending on the state, the Registrar or Small Business Commission will then make the appointment.
In some states, a tenant’s option notice is extended until a specific time after the current market rent is agreed or determined. Consequently, the tenant can exercise its option after being notified of the new market rent and have financial certainty for the option term.
As you would imagine, a market rent review can sometimes result in a decrease in rent. To offer better protection for tenants, retail lease legislation prevents a landlord from including ‘ratchet clauses’ in their leases. Ratchet clauses prohibit a decrease in rent following a market rent review.
This cheat sheet explains the key clauses you need to be aware of as a landlord in a lease agreement.
Commercial Leases
In a commercial lease, landlords will have greater discretion to determine the rent. This may affect, for example, how frequently reviews occur, the method to determine the review and whether an agreement can set the rental amount.
Most commercial leases only allow the landlord to initiate a market rent review. Unless otherwise specified in the lease, the landlord can initiate the current market rent review after the new term begins. Likewise, they can request the tenant to backdate the payment to the lease commencement date. This raises potential problems for tenants who want to know the market rent before deciding to renew their lease and avoid a lump sum bill for back-dated payment.
Unlike retail leases, which retail legislation protects, commercial leases may also contain a ‘ratchet clause.’ This clause prevents the rent from going down. Consequently, suppose the current market rent is subject to a ratchet provision and can only increase in value. This does not necessarily reflect the property’s true ‘market’ value if the market has, in fact, fallen. Before entering into a lease as a tenant, speak with a leasing lawyer to see if there is a way to remove this clause from the lease agreement.
Similar to a retail lease, a commercial lease generally provides that if a dispute arises between the tenant and the landlord regarding the current market rent, a valuer will determine it. You must understand that these market review processes should be negotiated between both parties. This will allow parties to reach a rental amount that is aligned with market rates and that is financially viable for the business to continue to operate.
Key Takeaways
Market rent review largely depends on how parties draft the exact process into a lease. Likewise, parties must consider if the lease is retail and subject to retail legislation. Understanding the market rent review process before committing to a lease is crucial to avoid future disputes. In particular, understand how the new amount will be calculated, the factors considered, and the dispute resolution procedure.
If you would like assistance reviewing your lease document or require advice before entering into your lease, our experienced leasing lawyers can help as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers who can answer your questions and draft and review your documents. Call us today at 1300 544 755 or visit our membership page.
Frequently Asked Questions
Market rent reviews usually occur when a tenant exercises their option to renew the lease or at specific intervals during a long-term lease.
Retail leases are governed by state legislation, and market rent is typically determined by a specialist valuer if the landlord and tenant cannot agree on the amount.
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