Reading time: 7 minutes

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. There are a number of factors that you should take into account when negotiating the terms of rent review provisions of a commercial lease.

Rent reviews generally take place on each anniversary of the lease commencement date. There are three common methods of rent review:

  1. Review to market;
  2. Consumer Price Index (CPI); or
  3. Fixed percentage increase.

This article will outline how a rent review works and it will cover the three common methods of rent review that you may choose for your commercial lease. 

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 current market’s rental rates. 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.

What is the Process of a Market Rent Review?

Subject to the terms of your specific lease, the first stage of the market rental review process usually starts with the landlord sending a notice to the tenant. The notice sets out what the landlord’s proposal for the current market rent is. If the tenant approves the new amount, the amount proposed by the landlord is considered to be the current market rent. However, if the tenant does not agree with the landlord’s assessment, the two parties commence negotiations. If they fail to reach an agreement, an independent valuer is appointed. They will make an assessment based on the directions and parameters provided for both parties’ lease and submissions. The valuer’s determination is then usually final and binding. 

It is worth noting that retail leases have specific state-based legislation that regulates the process for carrying out a market review. This article only focuses on rent reviews for commercial leases. 

How Does a CPI Rent Review Work?

A CPI rent review is directly connected to the movement in the consumer price index (CPI). The CPI is a measure of inflation. It applies according to a complex formula contained in the lease. The Australia Bureau of Statistics (ABS) publishes the CPI for each location in Australia. So, your lease will usually specify which CPI rate applies depending on the state or city of the premises. 

How Does a Fixed Percentage Increase Review Work? 

A ‘fixed percentage increase review’ is simply a fixed increase on the rent. The rent will increase by the amount of the fixed review every year on the commencement date anniversary. It is usually between 2%-5% of the current rent per year.

It is also possible to have a combination of these two types. For example, the rent review may be CPI + 2% or the higher of CPI and 3%.  

When Are Rent Reviews Conducted?

CPI reviews and fixed percentage-based reviews are conducted once a year during the term. They are generally (although not always) on the commencement date’s anniversary.

For example, if your lease commenced on 1 January 2020 with fixed 2% reviews, the next review would take place on 1 January 2021, then 1 January 2022, etc.

Market rent reviews are generally only carried out at specific times during the term of the lease. Most commonly, upon exercising an option for renewal as a means of ‘resetting’ the rent to the then-current market conditions. It is quite expensive to carry out market rent reviews. They typically require independent valuations and submissions from the parties if there is a disagreement. Hence why they are not typically undertaken every year.

Which Rent Review Method is the Right Choice?

If the market conditions look strong and have momentum, a market rent review or a CPI rent review is a favourable option for the landlord. You will usually see market rent reviews occurring when a lease option is exercised rather than on a yearly basis. However, if the conditions are unstable, landlords may prefer to use a fixed increase rent review (or a combination) to avoid decreasing the rent. 

For example, a market rent review would most likely not be favourable to the landlord in the times of the COVID pandemic. This is due to the marketplace experiencing unusually lower demand, partly due to travelling restrictions and border closures. It would most likely result with a rent reduction after completing the rent review in a weak market in these situations. 

From a tenant’s perspective, CPI rent reviews are favourable in weaker economies where the CPI is likely to go down. If the economy is looking good, this can mean that rent may increase as mentioned above. For this reason, when you are deciding which method to go with, it is important to consider the future market conditions. Not just the conditions at the time of signing.

Another advantage of the CPI rent review or the fixed percentage increase is that these methods are known amounts. Therefore, there is little to no dispute or expensive process to follow (as these reviews are applied automatically). Contrarily, this is unlike market rent reviews where there is a lengthy process and room for dispute. 

Ratchet Clauses

As a tenant, you will most likely not want to include a ratchet clause in your commercial lease. These provisions prevent rent falling beneath the original rent specified in the lease under any circumstances, including rent reviews. The law prohibits these provisions in retail leases but not in commercial leases.

Therefore, you would want to negotiate for such clauses to be removed from the lease before signing. 

Key Takeaways

If you are considering entering a retail or commercial lease, you may want to seek legal advice regarding the different rent review methods. This will ensure you understand how these methods will apply in your specific lease. When negotiating with your landlord it is important to consider the lease terms and which rent review method will be included in your lease. If you have any questions regarding your commercial lease or rent review, contact LegalVision’s leasing lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

Why is a market rent review necessary?

for your commercial lease in line with the current market’s rental rates. It ensures the landlord is charging a fair amount that is on par with the rates of nearby comparable properties. 

What is a CPI rent review?

A consumer price index (CPI) rent review is connected to the movement/inflation measured in the CPI. The CPI rate used will usually be specified in your lease based on your state, city or premises and it will reflect the Australia Bureau of Statistics (ABS) published rates. 

What is a fixed percentage increase review?

This type of review is simply a fixed increase on the rent. This means that each year the rent will increase by the fixed amount on review. It is usually between 2%-5% of the current rent per year.

Webinars

Construction Contract Essentials

Thursday 12 August | 11:00 - 11:45am

Online
Understand how construction contracts are drafted and how to protect your construction business.
Register Now

Startup 101: Understanding Cap Tables and ESOPs

Thursday 19 August | 11:00 - 11:45am

Online
Cap tables and employee share option plans are essential for fast-growing startups. Learn more with this free webinar.
Register Now

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

The majority of our clients are LVConnect members. By becoming a member, you can stay ahead of legal issues while staying on top of costs. From just $119 per week, get all your contracts sorted, trade marks registered and questions answered by experienced business lawyers.

Learn more about LVConnect

Need Legal Help? Get a Free Fixed-Fee Quote

If you would like to receive a free fixed-fee quote or get in touch with our team, fill out the form below.

  • 2020 Excellence in Technology & Innovation – Finalist – Australasian Law Awards 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice – Winner – Australasian Lawyer 2020 Employer of Choice Winner – Australasian Lawyer
  • 2021 Fastest Growing Law Firm - Financial Times APAC 500 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review 2020 AFR Fast 100 List - Australian Financial Review
  • 2021 Law Firm of the Year - Australasian Law Awards 2021 Law Firm of the Year - Australasian Law Awards
  • Most Innovative Law Firm - 2019 Australasian Lawyer 2019 Most Innovative Firm - Australasian Lawyer