Rent reviews in commercial leases
A variety of clauses to suit different situations
Negotiating commercial leases can involve a significant amount of crystal ball gazing – particularly when some leases can last decades. As recent times have shown, the landscape at the start of a lease can be miles away from the situation at the end of the lease. One area where the shifting sands can bite for long-term leases are the rent figures. Without appropriate rent review clauses to adjust the rent, any landlord could find themselves with a vastly undervalued rental as the lease progresses.
Types of rent review
Not all rent review clauses are alike. There are various methods of calculating changes to rent, these include:
Market rent review
This review adjusts the rent so that it reflects the current market value of the lease. It allows the rent review to take into account the general market conditions and factors specific to your property such as zoning and the desirability of your property’s location.
A market rent review can be particularly helpful if you have a gross lease, given the market value of the property will affect some of the operating expenses you must cover as a landlord such as, insurance and rates.
One risk of market rent reviews are that they can lead to a dispute about the quantum of the actual market rent. You and your tenant may have to bear the cost of valuations or, in a worst case scenario, legal action to settle the appropriate rent.
CPI rent review
The rent is aligned to the Consumer Price Index (CPI), a measure of inflation set by Statistics New Zealand. Essentially, this type of rent review helps prevent inflation decreasing the real value of the rental over time.
A CPI rent review usually includes a set formula for calculating the rent so there is reduced likelihood of a dispute or large fluctuations in the rental figure. However, the rent adjustment cannot take into account that the value of your property might be increasing faster than the rate of inflation.
Fixed percentage increases
Any rent changes are agreed at the time you enter your lease with your tenant. This does lead to certainty up-front about the quantum of a rent increase. However, as with CPI rent reviews, this could mean the rent does not reflect the market rent if the market conditions change.
A market rent review or a CPI rent review could, in theory, see the rent decrease if the market or the CPI falls (as relevant). This can be avoided by adding a ‘ratchet’ to your rent review clause, which limits when rent can be decreased as a result of a rent review.
There are two different types of ratchet clauses:
Hard ratchet: This clause only allows the rent to move upwards. It cannot decrease below the previous amount payable. This is more favourable to landlords than a ‘soft ratchet’.
Soft ratchet: The rent can decrease as a result of the rent review but never below a set figure, such as the rent at the start of the current lease term.
Timeframes for rent review
Another significant factor to consider when negotiating rent review clauses is the frequency of rent reviews. The rent reviews could align with any lease renewals, occur annually or follow some other frequency that suits you and your tenant.
If you vary the lease to extend its expiry date, it is essential you consider how this will affect the rent review dates. If rent reviews are expressed as occurring on specific dates, you should check whether the lease should be varied to add further dates to coincide with the longer term.
There are standard rent review clauses included in lease formats such as the ADLS Deed of Lease, but as with any term in a lease these clauses can be negotiated with your tenant to best fit the circumstances of the lease.
We recommend you talk with us before signing any commercial lease to ensure it contains the right combination of rent review clauses to suit your plans for the lease and your tenant.