Documents that Pay the Rent – Understanding Rent Review in Retail Leases

Lease Agreement

Whether you are a landlord or a tenant trying to run your business from leased premises, it’s important to have a clear and comprehensive document that sets out everyone’s rights and responsibilities. In addition to having everything in writing, it is important to also obtain sound legal advice when it comes to understanding the rights and obligations of the parties to certain leases. 

The Retail Leases Act 1994 (NSW) (“the Act”), sets out a comprehensive framework of processes, restrictions, and protections for tenants that fall under the scope of the Act. 

Landlords may find that their lease inadvertently falls under the scope of the Act as a “Retail Lease” as a consequence of the type of business run by the tenant; the location of the premises, regardless of the use; or even the ownership and use of the neighbouring premises. 

It is important to obtain advice as to whether the Act applies to a proposed lease. If the lease falls within the scope of the Act, the Act overrides any clauses of the lease that are inconsistent with the Act, and the parties should be aware of their obligations to ensure that the transaction runs smoothly from start to finish.

Rent

Even before the Lease has commenced, the Act begins to set out requirements regarding the rent. The rent and particulars of the future rent review must be outlined in a Disclosure Statement prior to the parties entering into the lease. 

Moving forward, the lessee is not liable to pay rent, or any other amount payable under the lease by the lessee such as outgoings, until the lessor has substantially complied with the lessor’s fitout obligations

Rent Review

It is usual for a lease for a period of several years to include a mechanism for the adjustment of rent. Section 18 of the Act outlines several requirements and restrictions for the adjustment of the base rent in a retail lease. 

Frequency of Rent Review

A retail lease must not provide for a change to the rent less than 12 months after the lease is entered into and must not provide for a change to that rent less than 12 months after any previous change to that rent, unless such changes to the rent are a specified amount or percentage.  

Restriction on Ratchet Clauses and Taking the Higher of Different Methods. 

It is common to see a retail lease implement yearly rent reviews either based on a fixed percentage, on applying the CPI Index, or a market rent review.

The Act makes void any retail lease clause that acts to allow a party a discretion to choose between different rent review methods on a particular occasion or to choose whichever of two or more different methods would give a higher rental increase. 

A Ratchet Clause is a clause in a will that limits the application of a rent review method to the extent that it results in a decrease in rent. The Act makes void any ratchet clause relating to retail rent review, or any discretion for a party to elect not to apply a particular method on a particular occasion. Particularly in recent market turbulence, an example of this is where a landlord would seek to avoid application of the Market Rent Review where it resulted in a rental amount less than that currently being paid by the tenant. 

Seeking Market Rent Review Before Agreeing to An Option

It is common to see a Market Rent Review implemented in a longer-term lease from time to time, such as when the lessee exercises an option to renew the lease. This process allows the rent to be reviewed where it may otherwise have been adjusted by an arbitrary percentage for several years previously. 

The Act outlines what is to be considered in determining the market value rent, as well as what is not to be included, such as the goodwill generated by the tenant’s lease. The lease also sets out the mechanisms for appointing a valuer to determine market value where the parties are unable to agree between themselves. 

Another often overlooked mechanism afforded by the Act is for the lessee to seek that the market value be determined early. This is particularly helpful to a tenant where they wish to know the proposed market value before exercising the option to sign on for a new lease. 

Section 32 of the Act allows the lessee to seek a determination of the market rent within the period between 6 months and 3 months (or 3 months and 30 days in a lease of 12 months or less) before the last day that the option for a further term must be exercised in the lease. If the lessee makes the request, the time period to exercise the option is varied to the period being 21 days after the rental determination is notified. 

If the determination is not provided within 21 days before the end of the term of the lease, the lessee may exercise the option within 21 days after the determination is notified in writing to the lessee (whether before or after the term of the lease), and the term of the lease is extended by the appropriate period to enable the lessee to exercise the option after the lease would otherwise expire. 

If you are a current or potential landlord or tenant to a commercial or Retail Lease requiring advice or assistance, contact Baker Love Lawyers.

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