A guide to commercial leases
You think you have found the perfect location for your business. What are the key things to watch out for with a commercial lease?
Total occupancy cost
The first and most obvious is the cost. And a lot of that can be hidden.
James Reeves, associate director at LJ Hooker Commercial, says the first thing to understand is the total occupancy cost. Is the rent inclusive of the landlord’s operation costs of owning the property, or do you have to pay the landlord’s outgoings which may include land tax, council rates and water connection rates?
Ask: Is rent inclusive of the landlord’s operation costs?
“You might be paying rent of $50,000 a year but you might have further operating costs or outgoings of another $30,000 a year,’’ Reeves says.
“You need to know that in advance. You need to know whether you’re getting into a gross rental deal or net rental deal so you can know your total occupancy costs and project that forward and understand for the life of the lease how much it will cost you to be there.”
The other part is understanding the escalation clauses in the lease. The lease will likely be increased annually on the anniversary date by a percentage. That can be as little as CPI which varies. Or the landlord might try to secure a fixed rate of between 3% – 5%.
“Your rent goes up annually and if you’re committing to a five-year lease, it’s very smart to project that out in advance in terms of the cash flow and see what your costs are going to be and what you will be paying each year,’’ he says.
For sure, it’s possible to negotiate incentives like rent-free periods by offering the landlord a long-term lease but Reeves says you should be careful. “If you’re going in to get the cheapest possible rent, the landlord will be less likely to build you any office space or provide you with any extra incentive to be there,’’ he says.
It’s possible to negotiate incentives like rent-free periods, but be careful.
Fit-outs are usually done at the tenant’s expense, unless of course the tenant might be offering the landlord the opportunity of long term lease.
Tenants should also be mindful of the make-good clause in the lease.
Reeves says you might see changes to the property as an improvement, but to the landlord they’re not worth anything. A standard make-good clause ensures you return the place to the condition it was in when you took over the premises.
“The devil is in the detail there because commercial leases can be very much written by the landlord and there is no industry standard.
“Your retail leases have a bit more protection in them but a commercial lease might have things where you have to repaint and recarpet before you leave.
“You need to understand what you’re getting into if there is a make good clause in the lease.
“You can do whatever you want to the place but if you have to rip it all out and then turn it back into the clean shell how you found it, it’s also going to be a cost on the way out.”
Be wary of investing too much money in a fit-out that will need to be stripped away when you leave.
He says tenants should also watch out for the upfront costs in every lease.
“You will have to put up security,’’ he says. “No landlord these days will accept a business without a three month, or four month or six month bank guarantee. Cash is not as good as a bank guarantee.”
Add to that the extra costs incurred if the landlord wants a solicitor to draw up the lease agreement. That’s an extra $1500-$2000.
To get the best deal, he suggests prospective tenants look around.
“You need to do your market research. Look around, speak to commercial agents to see what the going market rents are for the premises you are looking at. Seriously evaluate each property you are looking at because each property will be different and offer different things to your business.”
That also means evaluating what’s important for the business, such as exposure or parking. “Some businesses go into a place and realise they don’t have enough parking and their business is in a lot of trouble,’’ he says,
Another important thing to evaluate as part of the commercial lease is the council zoning.
“I have experienced it first-hand where tenants have not done their homework and signed the lease and committed to the property only to find out six months later that that the council says you can’t operate in this zone without approval, we need an application from you and a town planner.”
The means prospective tenants need to look at the council website, the planning documents and speak to the duty planner. And remember, it’s not the responsibility of the landlord or real estate agent to pass this information on.
“My advice to tenants is this,’’ Reeves says. “Understand the zoning of the property and what would be permissible.
“Secondly project a cash flow with a five or 10-year budget factoring in the likely rent you pay including the annual increases and understand what it might cost you to do you fit out and make your changes.”
In other words, when negotiating a commercial lease, evaluate the barriers to entry.