Commercial leases may contain many provisions to determine how the landlord will review the rent. Not only is this confusing, but as a tenant, you may have to agree to a particular method during the negotiation process without being sure about which best suits your needs. Below, we explain the advantages and disadvantages of the three most common methods of commercial rent reviews.
1. Fixed Percentage Increase
The ‘fixed percentage increase review’ is seemingly the most common method that landlord’s favour. The percentage amount represents a steady increase in rent at a discretionary figure.
Calculating and applying a fixed rent increase is also straightforward and leaves little to no room for disputes as the fixed percentage increase is automatically applied on each of the rent review dates.
As a tenant, you may try to negotiate for the percentage rent rate to be on the lower end. However, the end figure will most usually come down to supply and demand. At present, a percentage rent increase rate could fall anywhere between 2% being near the consumer price index, to 5% which is on the high side of the market.
2. CPI Rent Review
Commercial rent reviews which align with the movement in the Consumer Price Index (CPI) represents the fairest commercial rent review method for tenants. However, most landlords with high demand premises would be reluctant to agree to this method as it accounts for a small return on investment.
The formula for calculating CPI should be limited to the location of the premises (i.e. state based) to avoid taking into account the CPI index of more expensive markets. It is more often the case that if a landlord agrees to a CPI review, the formula would also include a fixed percentage increase so that the rent review method would be CPI + fixed percentage increase. Calculating CPI increases is also straight forward, as a quarterly publication of the CPI figures is readily accessible.
3. Market Rent Review
Market rent review can be a double edge sword for both parties as the movement in market activities can go either way. The process of determining the current market rent is also more involved as both parties are required to reach agreement on the market rent amount, and any dispute is referred to a third party jointly appointed to make a determination.
This process is time-consuming and costly in the event of a dispute. Furthermore, the result will not necessarily be in either the tenant or the landlord’s favour.
It is common for a third party valuer to make a market assessment of the current market rent. The third party valuer may give the market rent a decreased value based on factors of market movement and the location or state of the premises.
For non-retail leases, a landlord should ensure that a market rent review does not result in a decrease in rent by having a provision in the lease which states that the market rent cannot decrease.
Entering into a lease can be risky if you have not carefully factored the rent amount and the way it could change over the course of the lease term. There are ways to structure your commercial rent reviews to ensure a fair outcome. If you are unsure of your rights as a tenant or would like assistance with your lease negotiations, get in touch with our commercial leasing lawyers on 1300 544 755.