Commercial leases: make sure you know what you are getting into

Sandra was excited to be setting up her beauty salon. She had worked as a beauty therapist for a number of years, and there was already quite a bit of interest in her new business. She had also managed to find the perfect place to set up her salon. Now, she needed to review the lease documents the landlord had provided her with. Not so exciting!

Entering into a lease agreement may seem like a simple transaction, but there are actually quite a few things to think about from the point of view of a tenant. Here are some of them:

1. Rent Reviews:  Are the rent reviews to “market rent” or “CPI” (Consumer Price Index)?  Market rent is assessed by a valuer generally whereas CPI is based on the increase in the value of products and services over time based on the Reserve Bank’s calculator (a set percentage).
2. Ratchet clauses:  Is it possible for the rent to decrease on review?  “Ratchet clauses” are clauses that prevent this from occurring. The standard form lease provides that rent from the review date (for a market rent review) shall not be less than the rent payable as at the commencement date of the current lease term. It is important to ensure that you will not be tied to rent above the market value due to such a clause.
3. Term and rights of renewal:  What is the term of the lease, and are there any rights of renewal? It is difficult to terminate a lease before the expiry of a term, so you should think carefully about the length of the term that you are committing to.  Sometimes tenants will have a short initial term while they try to get their business on foot, with longer terms for the following terms (if they renew the lease).
4. Reinstatement:  To what extent are you required to reinstate (ie return) the property to its original condition when you leave? The standard lease requires you to remove at the end of the lease any alterations you’ve made to the premises. This may involve substantial cost, particularly if you have renovated the property. If you envisage making alterations, make sure that you have the lease amended to take this into account.  It is also a good idea to take photos of the premises before you move in and include them in the “Premises Condition Report” within the lease so you have those for comparison purposes, to show what the original condition of the premises was at the time of signing the lease.
5. Outgoings:  What outgoings are you required to pay? Outgoings are the costs in relation to a property that a tenant is required to pay over and above the rent. The standard form lease makes tenants liable for a reasonably broad range of outgoings, including the provision of toilets and rubbish/recycling charges. You should think about the likely costs you will incur before agreeing to take responsibility for these outgoings.  You should also look at how regularly these are to be paid, and whether these are to be paid directly or to the landlord.
6. Guarantee:  Are you required to guarantee the lease?  If you are taking the lease in the name of a company or other entity then generally landlords will want individuals (generally directors in the case of a company) to be personal guarantors for the lease.  The individuals will be liable to pay rent and perform the terms of the lease if the tenant company fails to do so.
7. “No Access” period:  How long should it be before you can terminate the lease if you are unable to gain access to the premises (and they are not destroyed or damaged)? “No access periods” were inserted into the standard form lease after the Christchurch earthquake (eg the red zone). During this period your business interruption insurance (if any) will also be relevant.
8. Signage:  Does the landlord consent to your signage? Signage is an important part of your business, but the standard form lease requires you to seek the landlord’s written approval before affixing signage to the building exterior.
9. Works prior to signing:  You should consider inserting in the lease a provision to require the landlord to repair any leaks or other issues with the premises before the date you commence the lease, particularly if the building may be a ‘leaky building’.
10. Fit out:  Who is paying for the “fit out” of the premises (ie in Sandra’s case putting in a counter, shelving, reception area etc)?  Sometimes landlords will contribute to this, especially if it is seen to increase the value of the premises for future tenants.  You need to be careful to consider who owns the fit out at the end of the lease and make sure that it is documented.
11. Insurance requirements:  Are you required by the landlord to have any particular insurance in place?  Sometimes landlords require tenants to have a certain level of public liability insurance, for example.
12. Rights to assign:  Can you assign the lease to another party?  This will be especially important if you ever sell your business in the future or move premises.  The standard form lease allows for assigning or subletting the premises with the landlord’s consent, but you should make sure this provision has not been removed.

It is important to take legal advice before signing a commercial lease.  If you are currently considering entering into a commercial lease, give Claire Tyler a call on (04) 473 6850 before you commit yourself.