How Commercial Tenants Can Avoid Common Leasing Mistakes

Monday, October 17th, 2016
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They say knowledge is power, and this is evident in the world of commercial negotiations, where parties who possess valuable information can use it to help them obtain the most favourable outcome possible.

Yet when it comes to commercial leasing, tenants often find themselves at an information disadvantage compared with landlords and their agents, for whom leasing activities are part of their core everyday business.

Whilst the extent of this varies, McGees Property director Ian Dimond says a knowledge imbalance will almost always be evident to some degree between the parties. This, he argues, typically starts with the commercial terms of the lease and extends to clauses which can be financially onerous yet are not always discussed during the initial negotiation. Make-good clauses which infer upon the tenant obligations to ensure that the condition of the premises at the time of vacation is equal to what it was at the time it was leased represent an example of the latter, he says.

“The mismatch will vary but it will almost always exist,” Dimond said.

According to Dimond, the imbalance manifests itself in a number of ways. Whilst some suggested those looking to rent in the Sydney market several years back could have asked for incentives in the realm of 35 per cent, he said, a number of tenants were not aware of the strength of their position when renting and instead settled for two to three months’ worth of free rent or a contribution toward the fitout cost associated with preparing the premises for occupation.

When renewing leases, a large number of tenants lack awareness about the level of incentives which they could achieve as a result of landlord efforts to entice them to remain at the premises. Indeed, some tenants do not even push for any incentives at all at this point.

Finally, even during times when market conditions become more favourable to tenants and rents begin to contract, Dimond says many renewing tenants are unaware of their potential to achieve rental reductions and instead settle for CPI related increases.

Dollar values can be significant, Dimond says. He says it is not uncommon to see tenants accepting incentive levels of 10 to 15 per cent less than what should be the case and has sometimes seen cases where no incentive is achieved at all even during times when incentives of up to 30 per cent were on offer.

Dimond is not alone in pointing to traps into which commercial tenants could fall. Tim Farley, national director of tenant advisory at Colliers International, says there are a number of areas where tenants might go wrong. Any lack of understanding of terminology such as the difference between net lettable area and gross lettable area, for example, could lead to an outcome where they were paying full commercial rates on a square meterage basis for areas such as bathrooms and elevator lobbies which are required to be provided but for which tenants arguably would not want to pay full square metre rates, Farley says.

Tenants should also be clear on how they are going to receive the premises, Farley adds. Where a landlord markets a building on the basis of planned upgrades, for example, prospective tenants should be clear about how firm and how far advanced these plans are. Otherwise, he says they could find themselves being sold on the basis of an upgrade which could in reality either never happen or be years in coming.

Finally, there is the issue of fit-out periods of up to two or three months during which the premises in question is being prepared for occupation. A number of tenants are not aware that they do not have to pay during these periods, Farley said.

In terms of reading the market, Farley says a common mistake is to apply a ‘rule of thumb’ approach toward estimating the level of incentives which should or should not be achievable. This is because many buildings have unique characteristics and different levels of demand among tenants.

Moreover, willingness on the part of individual landlords to offer incentives largely varies according to the amount of space which is vacant in the individual building in question, he says. He says a professional advisor will be able to understand the intricacies associated with the particular situation in question and advise on the best course of action.

When entering into an agreement, Farley says it is important that the contract contains effective review structures which enable the tenant to achieve fair market value, taking advantage by reducing rentals and maximising incentives where market conditions and a considered strategy will allow. The benefits of this can be substantial. In Melbourne over the past 24 months, for instance, many tenants should have been able to achieve incentives of 30 per cent or more when renegotiating their lease. This opportunity is often lost in cases where no effective review structure is in place and the tenant is an unlikely candidate to relocate (such as where the tenant has invested heavily in their fit-out or might have specialist equipment that is extremely expensive or disruptive to the business to move).

In terms of strategies, Farley says tenants should look at a variety of options and do so in sufficient time so as to maximise the extent of the leverage which they have available in the course of negotiations. Existing tenants should avoid giving off the impression of being a ‘sure thing’ from the viewpoint of their current landlord, who will otherwise fight harder and offer more in order to keep the tenant in question when that tenant is considered to be a legitimate flight risk.

Tenants should also think carefully about longer term business needs as well as the potential to use space more efficiently and therefore minimise space requirements. In the case of larger tenants entering into longer term leases, Farley suggests building flexibility into the lease in a number of ways, including break options and/or separate but concurrent lease documents where able to do so.

This, he said, facilitates the subleasing of one or more floors down the track in cases where space requirements are reduced, or a strategy to mitigate risk and exposure associated with a lease legacy might need to be implemented. For example, if a tenant outgrows current premises and needs to find larger premises part way through the term, they will need to address the remaining lease legacy of the current premises to minimise payment of double rent and to ensure that the business case for such moves is as strong as possible.

Dimond says it is important to understand critical terms of the agreement such as current rental levels and outgoing contributions along with how annual rent reviews and market rent reviews will work. Tenants who do not understand these things should seek professional representation and help, he said.

Finally, both Farley and Dimond stress the value of external representation. Not only do tenant representatives understand the important intricacies of contracts, Farley says, they are also able to use their connections to access off-market opportunities.

Moreover, where tenants wish to keep cards close to their chests, representatives can explore the market on their behalf without revealing their identity. Finally, the ability of an agent to bargain at arm’s length on behalf of the client enables that agent to adopt a more assertive stance whilst protecting the relationship of the tenant with their existing landlord, Farley says.

Dimond agrees.

“There’s an old adage that you should never negotiate for yourself” he says.

“There is a lot of truth in that.”

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