It is common for a commercial lease to contain a method which explains the process of increasing the rent incrementally as the term of the lease progresses. This is known as the rent review clause. These clauses can be quite technical and hard for tenants to understand. There are three common methods of rent review:
- fixed percentage increase;
- consumer price Index (CPI) increase; and
- market rent review.
This article will discuss the advantages and disadvantages of each method so that you, as a tenant, are informed to make the best choices for your lease agreement.
1. Fixed Percentage Increase Review
A ‘fixed percentage increase review’ is a fixed rent increase on specified dates during the lease term, usually the anniversary of the lease. In practical terms, this means that the lease agreement will specify the dates that the rent increase will begin and the amount of the fixed review. This amount is usually anywhere between 2% to 5% per year.
Advantages of a Fixed Percentage Increase Review
Calculating and applying a fixed rent increase is generally straightforward. Subsequently, it leaves little room for disputes as the fixed percentage increase is automatically applied on each of the specified dates.
Furthermore, a fixed percentage increase review provides certainty for both your landlord and yourself as you know how the rent will increase each year and can budget accordingly.
Disadvantages of a Fixed Percentage Increase Review
As a tenant, you may wish to negotiate for the percentage rent rate to be lowered. However, the end figure will usually come down to supply and demand. Currently, 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.
Another disadvantage is that if the economy experiences a downturn or recession and you are paying a high rate (such as 5%), your rent may be increasing disproportionately to your business growth.
2. CPI Rent Review
A CPI rent review is directly related to the movement in the CPI. It is applied by a complex formula (usually related to the city or state that the premises are in) contained in the lease. The Australia Bureau of Statistics (ABS) publishes the CPI for each location in Australia
Advantages of a CPI Rent Review
CPI represents the fairest commercial rent review method for a tenant as it keeps pace with the economy. Furthermore, in recent years, the annual increases have been quite small.
Disadvantages of a CPI Rent Review
Most landlords with high demand premises would be reluctant to agree to this method as it accounts for a small return on investment. Often, they can demand more under market rent.
This issue is often dealt with by a lease including a CPI increase plus a fixed percentage increase, such as CPI + 2%. When combining the fixed increase and the CPI, the review keeps pace with the economy and the market.
3. Market Rent Review
A market rent review allows the landlord to re-assess your rent for the premises so that it keeps pace with the financial market.
Advantages of a Market Rent Review
A market rent review can be a double-edged sword for both the landlord and yourself, the tenant. This is because the movement in market activities can go either way. If the market has not moved or has decreased, it can greatly benefit you as the tenant. The rent will keep pace with the market and may actually be less than a fixed price increase.
Retail leasing laws across Australia prohibit ratchet clauses in retail leases. A ratchet clause ensures the rent can only increase or remain the same. These retail laws are advantageous for you as the tenant because the rent can decrease if the market collapses.
Disadvantages of a Market Rent Review
The market rent might increase rapidly in some markets and create uncertainty for your rent budgeting for upcoming years.
At first instance, the landlord or the landlord’s agent will conduct the market review and advise the results to the tenant. However, if you do not agree with the market review proposed by the landlord and wish to dispute it, the process can be time-consuming and costly.
Furthermore, in this case, the result will not necessarily be in either your 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 of the premises.
Entering into a lease can be risky if you have not carefully factored the rent amount and the way that it might change throughout the lease term. There are three main ways to structure your commercial rent reviews to ensure a fair outcome, being:
- fixed price increase;
- CPI increase; and
- review to market.
If you are unsure of your rights as a tenant or would like assistance with your lease negotiations, get in touch with LegalVision’s leasing lawyers on 1300 544 755 or fill out the form on this page.
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