Four tips to negotiating a commercial lease

Leasing a new premises is an exciting time. It could be a new business starting up? Perhaps an existing business growing taking on a second or third location? Or even, a business downsizing to achieve better efficiency. Whatever the case may be, putting the right steps in place to help your business blossom is a key part of success. Although an exciting chapter, getting your lease negotiation right before anything is signed is pivotal to your success.

Four ALM tips for a strong negotiation strategy:

1. Commercial Terms

Aside from finding the right property for your business’s needs, consideration needs to be put into the commercial terms to give you every chance of success from day one. Commercial terms can be thought of as the flour, eggs, butter, and milk when making a cake – that is, the main components. This will often include the rent amount, how much if any outgoings are to be paid, the length of the lease, the right to any renewal options and how the rent is to increase during the lease term. These components will always vary depending on the business and the landlord. There is no such thing as “the same deal” in commercial leasing.  Ensuring the terms are right for your business could be the deciding factor between success and failure.

2. Rent review mechanism – Fixed percent or CPI

Often a variable in many negotiations is the way in which the rent is reviewed (increases each year). One method that is particularly topical at the moment is for the annual rent increase to be calculated by CPI (Inflation). Historically, CPI has hovered around 3% making the rent increases on most businesses manageable. However, in today’s economic landscape, CPI has skyrocketed to 5, 6 or 7% making rental increases more difficult to deal with and unless your business is growing at least at the same rate, you will be going backwards in real terms. One alternative we recommend if CPI is running hot is negotiate to a fixed percentage increase. Generally, this may be agreed at an annual increase of between 2.5-4% per year. Having a fixed annual increases rather than an unknown CPI will also help you budget for future years with the confidence to predict how much you’ll need to pay on rent over the full term of the lease.

3. Rent review mechanism – Market review

If your lease has further options to renew (maybe something like a 5 + 5 years), in most cases it is best to include a market review on renewal.  This will allow the rent at that time to be reset to market conditions to ensure the rent is reflective of the market at that time. If the lease does contain a market rent review provision it first allows the landlord and tenant to negotiate the rent based on current market conditions. If the tenant and the landlord can’t come to an agreement on the rent figure, in many situations the Retail and Commercial Leases Act allows for the rent to be set independently by a valuer appointed by the API.

In most situations when a lease contains a market review provision, we believe it far better (both financially and to retain a healthy relationship between the parties) to try and negotiate a result rather going through the independent determination process. It can be costly and the results can sometimes be unpredictable for both parties involved.

4. Providing Security over a Lease - Bank or personal guarantee

When entering into a lease, most landlords will ask for a guarantee of some kind against the risk of default. Typically, this is provided to a landlord in the form of a bond, a bank guarantee or personal guarantee. Each situation is different, sometimes it could be one or the other, sometimes two being a bond or bank guarantee along with a personal guarantee.

These remain a critical piece of the puzzle for both landlord and tenant during the life of a lease due to the possible ramifications. If the business can’t afford to pay the rent or defaults on the lease, if there is a personal guarantee to the lease, the individual guarantor can be found liable to meet the lease commitments. A bank guarantee is often a better way to go for both parties as its clean and easy to take up if ever required. Some landlords will seek the bank guarantee to not have an expiry date which can be problematic if it gets lost. A solution to this is to agree on an expiry about 2 months after the final possible date of the lease as that allows the parties to clean up any outstanding rent, complete all makegood obligations and finalise the relationship.

The other thing we suggest is limiting the bank guarantee to no more than 3 months of rent but this will vary usually depending on the risk the landlord is taking

Rent is often a business’ biggest fixed expense and can make or break it. Wages are also a significant cog in the wheel but you can adjust wages throughout the journey but once you sign a lease, you are locked in for the duration of that lease. Getting the lease right from the outset is pivotal to business success. Get it wrong, and it could spell disaster with implications many don’t consider when excited by the prospect of being a business owner.

 Always remember, the right thing for someone else may not be the right thing for you. Take the time to understand what you’re agreeing to, ask questions, be curious – get help from your accountant or business adviser. When in doubt, our team of consultants are ready to alleviate any fears, answer all questions you may have and guide you on the right course to making the best decisions possible at that particular point in time.