Rent costs are likely to be one of the ultimate factors in determining where you base your business. Without having negotiated a large number of commercial leases, you may not even be aware of how many variables there can be.
Rent review provisions, one of the key elements of any commercial lease, should be highly important to both landlords and tenants. Landlords want to achieve maximum rent and maximum value, whereas tenants want to ensure they are not tied to paying rent above market rate or what they can afford.
What types of rent review are there?
The method of rent review is agreed between landlord and tenant and there are numerous ways this can be done, ranging from fixed rent increases, to linking the payable rent to the tenant’s turnover or another method agreed between the two parties.
Market Rent Review
In a market rent review, the rent is assessed at market value at agreed intervals.
The usual process identified in the lease, is that the initiator of the rent review will have obtained a market rent review valuation to assist with determining the proposed rent. If this amount is not agreed to by both parties, each party will appoint a valuer and those two valuers will mutually appoint a third independent valuer. If the two valuers can’t agree the revised rent between themselves, then the third independent valuer shall determine the revised rent.
Market rent reviews are reflective of the current market and are good for commercial properties where demand is consistent. The rent will increase in line with the market rate (subject to the terms of the lease).
Consumer Price Index (CPI) rent review
This method links rent to the CPI published by Statistics New Zealand. The most commonly used lease form in New Zealand is published by the Auckland District Law Society (ADLS) and contains the formula for calculating CPI rent reviews.
CPI rent reviews provide certainty as to annual rent increases. They also reduce the cost of the rent review process, as valuations are not required and are less likely to result in disputes as the CPI is published by Statistics New Zealand. However, this type of review doesn’t reflect the current market rate which may be considerably higher and therefore a landlord might not obtain the rent they could by using a market rent review.
So the rent could decrease?
A commercial lease will almost always contain either a hard or soft ratchet clause.
A hard ratchet clause means that the revised rent cannot fall below the rent payable immediately prior to the rent review. A soft ratchet clause means that the revised rent cannot fall below the rent payable at the commencement of the existing lease term.
Under the standard terms of the ADLS lease, a CPI rent review contains a hard ratchet clause while a market rent review contains a soft ratchet clause. In both cases, these clauses can be amended during lease negotiations.
One size doesn’t fit all.
The ADLS lease also gives the landlord the option to have a mixture of both market rent reviews and CPI rent reviews. Using a mixture would provide the landlord with some level of protection in the event that an imbalance develops between the true market rent and the CPI adjusted rent.
While market value and CPI are the most common methods for reviewing rent, they are not the be all and end all. If you would like to learn about other options or get some advice on your current commercial lease negotiations, get in touch!