The Top 6 Elements to Consider When Entering into a Commercial Lease
One of the most significant commitments when starting or growing a business is signing a commercial lease. It is important for tenants to understand the implications of committing to a lease before signing. This article will discuss the top 6 essential factors to consider before entering into a commercial lease.
- Terms and Conditions
Commercial leases typically include one of three methods for calculating rental increases periodically:
- CPI Rent Review: This is an increase based on the current consumer price index (CPI) rate, which is considered the fairest commercial rent review mechanism for tenants.
- Fixed Percentage Increase: This is a fixed percentage increase that is mutually agreed upon by the tenant and landlord before the lease is signed. The fixed percentage may fall between 3-4% and is favoured by landlords because it is a straightforward process.
- Market Rent Review: If the lease is about to expire and the tenant has an option to renew, there is generally a provision to review the rent to reflect current market rates.
In addition to the rent amount, it is important to consider the length of the lease and whether it aligns with the business’ growth plans. You may wish to negotiate more favourable terms, such as a shorter lease or options for renewals in accordance with your business’ growth plans.
Furthermore, it is crucial to factor in any additional costs associated with the lease, such as utilities, insurances, and outgoings. These costs can add up quickly so it is essential to consider them when assessing the overall costs of the lease.
- Maintenance Responsibilities
Another critical factor to consider when entering into a commercial lease is the maintenance responsibilities outlined in the lease. As a tenant, you may be responsible for repairs and maintenance of the leased premises, including common areas. It is essential to understand these responsibilities and budget accordingly for any unforeseen expenses that may arise.
- What is “maintenance and repair”?
Maintenance and repair are separate but related concepts. Maintenance refers to steps taken to avoid deterioration of the building and its systems through preventative and corrective measures. Examples of standard maintenance obligations of a tenant in commercial leases are painting, cleaning, servicing and maintaining equipment, clearing drains and gutters, and replacing light bulbs.
On the other hand, repair refers to portions of the premises that require fixing. Any damage by the tenant must be repaired by the tenant. However, it may not always be simple to differentiate between ‘maintenance’ and ‘repair’. For example, a component that has worn out despite regular maintenance may result in a dispute as to whether the cause is poor maintenance or reasonable wear and tear.
Standard retail leases usually require the tenant to keep the premises in the same condition as at the start of the lease unless the condition of the premises deteriorates due to ‘fair wear and tear’ or if making good of the premises requires the tenant to carry out structural repairs or make payments of a capital nature.
A detailed move-in checklist and move-out checklist can help establish the condition of the property and the responsibilities of each party. The move-in checklist should include a thorough inspection of the property and any existing damage or defects, as well as notes on the condition of walls, floors, appliances, and fixtures. The move-out checklist should include a similar inspection to document any damage or changes made by the tenant during their tenancy. Both parties should sign and date the checklists to acknowledge the condition of the property at the beginning and end of the tenancy.
- Permitted Use
The permitted use of the leased premises is another crucial factor to consider before signing a commercial lease. You must ensure that your business’ intended use of the premises aligns with the permitted use of the premises as reflected in the lease. If you plan to use the premises for any activities beyond the scope of the permitted use, you must seek the landlord’s approval.
It is important to be aware of any restrictions on the use of the premises, such as noise restrictions or limitations on operating hours. You should also confirm whether any zoning or planning laws affect your business’ operations in the leased premises.
You should also consider whether the leased premises meet your specific business requirements, such as customer/delivery access. It is crucial to ensure that the premises are fit for purpose and that any modifications or alterations required to suit your business needs are allowed under the lease.
- Security Deposit and Guarantees
Most commercial leases require a tenant to provide a security deposit at the start of the lease. The deposit amount is typically one to three months’ rent and serves as security against the tenant defaulting on the lease.
In addition to a security deposit, the landlord may also require a personal or corporate guarantee. A ‘guarantee’ is a legal agreement where the guarantor agrees to pay the rent and any other financial obligations under the lease if the tenant is unable to do so.
Under the Retail Leases Act 2003 (Vic), a landlord is required to hold a security deposit in an interest-bearing account, which must be returned (with interest) to the tenant within 30 days of the lease ending. However, the landlord’s obligation to return the security deposit only applies where the tenant has completed their obligations under the lease.
If there is a dispute over the security deposit, you can seek preliminary assistance from the Victorian Small Business Commission (VSBC). For example, if a retail lease has expired and the landlord’s agent has refused to refund the security deposit on the basis that the premises has not been reinstated to its original condition, the tenant can speak to a Dispute Resolution Officer at the VSBC for preliminary assistance.
- Termination and Assignment
Before signing a commercial lease, you should understand the circumstances under which the lease can be terminated and the process for assigning the lease to another tenant.
The lease will usually specify the notice period required to terminate the lease, which should be considered in line with your business’s future plans. You should also be aware of any penalties or costs associated with early termination.
Assigning the lease to another tenant can be an effective way to exit a lease agreement. However, the process for assigning a lease can be complex and the landlord’s approval is required. The lease will usually specify the conditions under which a lease can be assigned as well as any costs associated with the process.
If you and the landlord reach an agreement on early termination of the lease, it is important that the agreement be reflected in writing and that the agreement includes anything you both have agreed to as part of the lease ending early. Keep in mind that ending or breaking a lease early without agreement may result in you being liable for the rent owed from the day you end the lease until the end of the agreed term of the lease. Additionally, you might need to pay the landlord’s costs of re-leasing, which could include advertising and other associated expenses.
- Dispute Resolution
Dispute resolution is an essential component of any tenancy agreement, as disagreements can arise between landlords and tenants despite their best efforts to prevent them.
If informal negotiations between you and the landlord fail, mediation may be the next step. Mediation involves a neutral third party guiding a negotiation session between the parties. Most leases as well as retail lease legislation require mediation before going to court. Mediation can be a useful tool for finding a compromise as it allows both parties to express their concerns and work towards a structured solution. However, the mediator will not make a determination on the outcome, leaving it up to the parties to reach an agreement.
If mediation does not resolve the dispute, the parties may need to resort to legal action. In such cases, the rental agreement may specify a jurisdiction for legal proceedings or require the parties to attempt further negotiation before filing a lawsuit.
It is important for landlords and tenants to communicate clearly and regularly throughout the tenancy and for tenants to promptly report any damage or issues with the rental property to avoid disputes. Clear expectations and boundaries can help prevent misunderstandings and conflicts.
As a tenant, it is important to ensure that the lease aligns with your business’s future plans and that you have the necessary budget and resources to meet your obligations under the lease.
If you are considering signing on to a commercial lease, Constructive Legal Solutions can provide you with legal advice on your lease agreement to ensure that you understand all the key issues. Call 1300 632 247 or send your enquiry to email@example.com for tailored advice.