PROPERTY OWNERS – HOW TO GET THE MOST OUT OF YOUR LEASE
As agents our experience tells us just how important a well structured lease is when an owner wants to sell a property. History has shown that poorly structured leases can have a significant and adverse impact on the selling price achieved. The type of agreement used and the items of expenditure defined as recoverable outgoings can substantially impact the value and saleability of a property.
We asked Mark McAvoy of GM Lawyers to provide a brief check list of critical elements that owners should consider when negotiating new leases with tenants.
Introduction: Most owners will be aware that a lease should deal with the term (or duration) of the lease, the amount of rent to be charged, the type of outgoings to be recovered and the usual obligations to be imposed on a tenant.
There are other areas that are often overlooked during negotiations. Significantly, some of these areas are not addressed or dealt with sufficiently in a short form commercial tenancy agreement, so consideration of these may assist with the smooth operation of a lease.
The following check list highlights some of the important areas that owners should look for in a good lease.
Outgoings: The owners’ cash flow can be improved and record keeping simplified by ensuring that a lease entitles the owner to estimate the outgoings in advance and to recover from the tenant the outgoings in equal monthly instalments. A reconciliation of the actual outgoings is then carried out at the end of the year when a new estimate would be prepared. At that time any adjustments between the budget and actual expenditure can be made and where appropriate refunded to, or claimed from the tenant.
Types of Agreement: Frequently owners accept a ‘commercial tenancy agreement’ for short term leases. Commercial tenancy agreements provide a simple ‘off the shelf’ document that do not involve the use of legal advisers. Whilst they are convenient there are some pitfalls. CTA’s should not be used for terms greater than three years including all option periods where registration may be required. Furthermore, the make good and outgoings provisions are not comprehensive and arguably favour the tenant. For example, management fees and land tax are not listed as recoverable outgoings in a standard commercial tenancy agreement.
Security: The provision of security by a tenant is a major indicator of the financial strength of the tenant. An owner needs to consider the type of security that should be requested (e.g. personal guarantees from the directors, a bank guarantee or cash bond) to support the tenants’ obligations under a lease. If a bank guarantee is obtained, it would be prudent for this bank guarantee not to expire before the tenant has had an opportunity to carry out any make good or redecoration works at the end of the lease. It is preferable that a bank guarantee not have an expiry date. The quantum of a bank guarantee or rental bond should also represent a strong commitment by a tenant and consideration should be given to obtaining security for a minimum of three months.
Rent Reviews: The lease should clearly set out the mechanisms for any review of rent including market reviews. If there is a CPI increase, the formula should be set out. In relation to a market review, the lease should set out the necessary qualifications for a valuer and the matters that the valuer should take into account.
Periodic Bank Transfer: It is preferable that a lease allow the owner to require the payment of rent by periodic bank transfer. Many owners find this a useful tool for ensuring that tenants pay the rent in a timely manner.
Use: The lease should provide that the tenant has satisfied itself that the premises are suitable for the permitted use. In other words, the tenant must carry out its due diligence to ensure it can operate at the premises and if a lease is entered into, any restriction on the tenant operating at the leased premises should not be a valid excuse for the tenant not paying rent or not continuing with the Lease.
Floor Load Weights: The lease should require the tenant to observe maximum load weights. It would be prudent to provide to the tenant the maximum load weights before the lease commences to avoid any argument by the tenant that it was not aware of the loadings. This clause is particularly important where the tenant may operate equipment that may damage any hardstand area. Like any other repair and maintenance term, it would be prudent for the owner to commission an independent condition report at the commencement of the lease so as to minimise the risk of any dispute as to who caused the damage.
Indemnity and Release: The lease should provide that the tenant will release the owner from any claim for loss suffered by the tenant except where the loss is caused by the owner’s negligence. The lease should also provide for an indemnity in favour of the owner except in circumstances where the loss is caused by the owner’s negligence.
Insurance: The amount of the public liability insurance cover to be effected by the tenant should be specified. Usually this amount is $20 million.
Condition of Liability: Ideally, the owner would prefer a term requiring the tenant to first give the owner notice and an opportunity to rectify a remedial breach before the owner can be held to be in default.
Assignment and Subleases: Any proposed assignee or sub-lessee should be financially sound and capable of performing the tenant’s obligations under the lease. The lease should also provide that the tenant should have the onus of satisfying the owner in respect of these criteria. This is an important term as the owner may require additional security in circumstances where an assignee or sub-lessee is not as financially sound as the existing tenant.
Maintenance: A good lease will clearly set out the obligation of each party in terms of repair and maintenance.
Air Conditioning: A good lease should require the tenant to enter into a preventative maintenance contract for the regular servicing and maintenance of air conditioning equipment (if the tenant is responsible for this). The lease should also include a requirement for the tenant to provide the owner with a copy of the maintenance contract on request. This is an important term as the owner does not wish to be responsible for the cost of capital repairs in circumstances where those repairs were required as a consequence of the tenant’s failure to properly maintain certain equipment.
Redecoration/Make Good: The lease should clearly set out what is required of the tenant when the lease ends. The redecoration or make good clause may oblige the tenant to undertake certain works (e.g. repaint or replace carpets) regardless of the condition of the premises at the commencement of the Lease. This can be an important clause particularly in respect to long term leases. This term of the lease is perhaps the term that attracts the most attention at the end of a lease.
Rent Incentives: If a rent incentive is given, then the lease should provide that outgoings are still payable if that is the intention of the parties. The lease should also allow the owner to claw back any rental incentive amount in the event the tenant subsequently defaults in its obligations under the lease.
Mark McAvoy is a partner at GM Lawyers and practices in Property Law.