From a landlord’s perspective, rent reviews are an essential component of a commercial lease. Reviewing the rent at specified intervals ensures that the rent keeps pace with current market rates. Rent reviews can be conducted in several different ways and there are a number of factors that should be taken into account when negotiating the terms of rent review provisions of a retail or commercial lease.
Rent reviews generally take place on the anniversary of the lease each year. There are three common methods of rent review:
- Review to market;
- Consumer Price Index (CPI); or
- Fixed percentage increase.
How does a market rent review work?
The purpose of having a market rent review for your commercial lease is to try and keep the rental rates in line with the rental rates of the current market. In other words, to ensure the landlord is charging a fair amount that is on par with the rates of nearby comparable properties. These rates fluctuate largely due to the supply and demand conditions at the time. The landlord, real estate agent or property valuer can conduct a market rent review over a property.
When is a market rent review conducted?
It is common for Consumer Price Index (CPI) reviews and percentage-based reviews to be conducted once a year. Market rent reviews are generally only carried out at specific times during the term of the lease.
For example, a market rent review may occur every 3-5 years or upon exercising an option for renewal. It is quite expensive to carry out market rent reviews, as they typically require independent valuations.
Is a market rent review the right choice?
From a landlord’s perspective, market rent reviews are favourable in strong marketplaces. If the marketplace is underperforming, however, this can mean that rent actually decreases. For this reason, when you’re deciding which method to go with, you have to consider the future conditions of the marketplace and not just the conditions at the time of signing.
If the conditions of the market look strong and have momentum, a market rent review is a favourable option for the lessor. If, however, the conditions are unstable, it might be more beneficial (and less risky) to use a CPI or fixed increase method of rent review to avoid decreasing the rent.
What is the process of a market rent review?
The first stage of the rental review process starts with the lessor sending a notice to the lessee that proposes a change in the rent. If the lessee approves the new amount, the amount proposed by the landlord is considered to be the current market rent. If, however, there is a disagreement regarding the new amount, the two parties commence negotiations. If the two parties fail to reach an agreement regarding an appropriate rental adjustment, the tenant will usually be entitled to appoint an independent valuer to help determine a fair rental adjustment.
It is worth noting that retail leases have specific state-based legislation that regulates the process for carrying out a market rent review.
If you are considering entering a retail or commercial lease, you might need legal advice regarding which method of rent review to go with. To speak with one of our experienced leasing lawyers, contact LegalVision on 1300 544 755.