Four things to look out for with commercial lease agreements

Last week, Tom O’Brien wrote about six important issues to consider when negotiating your first commercial lease.

This week we’ll go into a bit more detail on commercial lease agreements, setting out a number of document specific clauses to keep an eye out for.

1. Retail lease or general commercial lease?

Every Australian state and territory has specific legislation relating to retail leases. This legislation is designed to provide additional protections to retail tenants, and impose a range of obligations on commercial landlords, when compared to non-retail commercial leases.

As soon as you’ve decided to enter into a commercial lease you should check whether the relevant retail leasing legislation applies.

Your commercial leasing lawyer will of course be able to assist, but this is something you should keep an eye out for yourself.

2. Term of the lease and options

One of the most important clauses to keep an eye out for when entering into a commercial lease is the term of the lease, and any options to renew the lease. It’s generally in the landlord’s best interests to ask for a longer initial lease term (for example five or 10 years), whilst the tenant is likely to be keener on a shorter period (three years is a good standard).

A start-up tenant is likely either to go out of business, or expand rapidly and need to move to larger premises, so is further incentivised to agree to only a short lease period. Obviously the type of property being leased, as well as the location, will have an effect on the term of the lease each party would like best.

Make sure you also take a good look at the options clause. An option allows the tenant to continue leasing the property at the term of the lease for a predetermined amount. It’s generally in both the tenant and the landlord’s interest to include an option clause, giving the landlord potential greater security of income, and the tenant the ability to make longer term plans for their business.

3. Rent and security

Obviously the rent clause is one of the most important clauses in a commercial lease agreement. Rent represents the landlord’s return from its ownership of the property and is a significant expense for the tenant in operating its business.

The rent for the initial term is specified in the lease. Any rent review (i.e. change in the rent) will also be specified in the lease.

The three most common review methods are CPI, fixed and market. The relevant review method is generally applied annually throughout the term of the lease. It is common for CPI or fixed reviews during the term of a lease and for a market review to occur at the expiry of the initial term and each option period.

In addition to rent, the landlord may seek security from the tenant to protect the landlord against default of the tenant (e.g. not paying rent). It is common for security to be for an amount equal to three to six months’ rent and to be by way of bank guarantee (if the tenant is an individual) or personal guarantee (if the tenant is a company, in which case the company’s directors provide personal guarantees). Obviously, as a tenant, you will want to avoid giving any form of guarantee.

4. Termination

Finally, make sure you review the termination clause in the lease. You need to be clear on what circumstances will lead to the termination of the lease. If you’re worried that the termination clause is overly onerous, take action.

To conclude

There are obviously a number of clauses you need to review in detail before signing a commercial lease. It’s critical that you have a commercial leasing lawyer review the lease before you sign it.

This article first appeared on StartupSmart.