Part 2: What is a rent review in a commercial lease?

Welcome to Part 2 on What is a rent review in a commercial lease? Here we will discuss any time limits that may apply, the process for conducting independent reviews and how to commence a market rent review.

Do any time limits apply?

It is in the interests of both parties to avoid drawing out the entire process. For this reason, your leasing lawyer should include a clause that imposes a time limitation on disputing the new rental amount. It is common for the commercial lease terms to stipulate that after a 28-day period, the proposed new rental amount will be deemed to have been accepted by the tenant if no response is received.

Independent reviews

If both parties agree to an independent review, both lessee and lessor have a chance to present submissions to the independent valuer. Once a valuer decides on an appropriate rental amount, their decision is typically binding. The 2 parties will generally share the costs of appointment.

When valuers conduct a valuation, they have the power to apply valuation principles fairly broadly. When drafting your lease agreement, your leasing lawyer should consider inserting clear valuation criteria for conducting market rent reviews. This criteria will set out what a valuer should and should not give consideration to and whether any assumptions should or should not be made.

Starting a market rent review

The terms of the commercial lease will typically dictate which party may start a market rent review. Generally, both parties are empowered to commence a market rent review. Having said this, there are some key distinctions to be made between commercial and retail leases.

A tenant is entitled to seek a ‘rental determination’ under section 32 of the Retail Leases Act (NSW). If the rental determination doesn’t occur before the option date, the option period will be extended to the date on which the tenant is notified of the determination. This allows the tenant to carefully consider the new rental amount when choosing whether to exercise the renewal option. If an early determination does occur, the tenant will have 21 days to exercise their option.

Time is usually of the essence in commercial leases. It is prudent that, as the lessor, you ensure that after a certain time you are entitled to commence the rent review process. These time limits must be strictly adhered to if you wish to avoid losing the right to review altogether.

What are ratchet clauses?

A ratchet clause is illegal in retail lease agreements. They aim to prevent decreases in rent following a market rent review. A decrease in rent might occur when the market conditions are weak and the rental amount decreases in the surrounding properties. As the market rent review must be a ‘true market rent review’, the new rental amount can technically be less than it was previously.

Should I use a market rent review?

The right method of rent review is largely dependent on the current and projected market conditions, as well as your individual business. If it appeals to you to have absolute certainty as to how much you will owe or be owed down the track, a fixed percentage or CPI may be more suitable. A market rent review is more risky, as it is difficult to know how the surrounding businesses with similar leases will perform. As a tenant, a weak marketplace might make a market rent review more attractive (the rent could decrease). If you’re a landlord, and the conditions look like they will continue to be strong in the marketplace, a market rent review might be the more profitable option and be worth the risk.

Conclusion

If you’re a landlord or a tenant in need of legal assistance in drafting or reviewing the terms of your retail or commercial lease, contact LegalVision on 1300 544 755 and discuss your matter with one of our leasing lawyers.