Thursday 26 September 2019

Commercial Investment Series - What Type of Lease

The importance of a well drafted lease cannot be overemphasised.  The needs of a landlord and tenant differ significantly when it comes to a lease, which is evident when solicitors start negotiating terms.

In basic terms there are four main types of commercial leases:

1. Fixed rental for a period of time

•  Positive – set and defined expenses; tenant and landlord know what rent is being paid each year.

• Negatives – as an investor, your expenses will usually grow over time, narrowing your margin over the term of the lease. This will also impact on the value of the property.

2. Fixed rental with CPI, fixed % or incremented reviews, adjusted annually for a fixed period of time plus options, at which time the rent is commonly reviewed according to market conditions.

• Most common.

• Positive – income grows, as the expense of operation and ownership grows, which is particularly important with Gross leases. Landlord and Tenant know what rent will be paid each year.

• Negatives – can lead to over rented space by the end of a term, which could mean a rental correction at market review. If you have a higher annual rent increase over a period of 5 years, this could lead to the tenant paying over market rent and result in the tenant looking elsewhere to find a cheaper tenancy at option/renewal or cause the tenant to get into financial trouble. CPI does not usually keep up with general expense increases such as rates, insurances etc.

• Minimum fixed rental plus a percentage of turnover

• Generally applies to retail leases.

• Positives – it can be a sign of faith in the tenant, as the landlord is potentially willing to concede on their guaranteed income to invest in the tenant’s potential to succeed and trigger the turnover rent provision. Provides information to the landlord surrounding the success of the centre, marketing campaigns etc.

• Negatives – if the tenant is not motivated or their marketing isn’t effective, both parties can be impacted by the reduced income. If there is an economic change that impacts the tenant, this could impact the financials.

3. Straight percentage of turnover

• Generally applies to retail leases and not as common.

• Positives – usually a higher percentage is allocated if it is percentage only, this is to offset the risk. If the tenant performs well, there can be a strong income opportunity.

• Negatives - this is sometimes undertaken to keep a tenant that may be at risk of leaving if it is a soft market. There is no guaranteed income, this may affect the valuation of the property.

For further information on sales and leasing please contact Your Commercial, 07 3148 9901 or sales@yourcommercial.com.au

 

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