A glossary of key lease terms
At Liberty Leasing we regularly post literature designed to empower and educate Tenants about commercial and retail leasing. Sometimes those articles can assume a significant level of base knowledge. So we wanted to create something solely for our first-time retailers! We have prepared a glossary of key lease terms that you will hear regularly during the site selection process and the initial negotiations. This glossary aims to add meaning to the jargon surrounding some key lease terms, and more importantly, teach you how to negotiate them.
Heads of Agreement / Letter of Intent
The heads of agreement is designed to capture the key commercial terms, however it is not a binding document. It is prepared prior to entering into the lease and is ultimately the document that the Landlord will give to their solicitor to prepare the lease. It is vital that any special conditions you have negotiated are clearly stated in the heads of agreement. If these special conditions are not sufficiently documented in the heads of agreement, the lease negotiation process can become quite lengthy (and costly).
There are a variety of ways that you, or your commercial Tenant advocate, can structure the rent payable under the lease. Of course, the rent is probably the most crucial of the key lease terms. Hence, when negotiating the heads of agreement ensure that you understand the difference between each structure and negotiate the one that is best for your business and the specific site for lease.
A net rent is where you pay a base rent and then make payment of outgoings and / or promotional levies on top of that base amount.
A gross rent is amount whereby any outgoings or promotional levies are effectively built into the base rent amount. It’s critical that you know all the numbers before being able to determine if a gross rent structure is better than a net rent structure for any specific deal.
Partial Gross Rent
This is a hybrid structure between a net rent and a gross rent. For example, you may pay a net rent and only some outgoings, such as statutory outgoings.
Percentage Rent (or Turnover Rent)
The turnover rent is an additional rent calculated on a percentage of the gross sales derived from the premises, to the extent that they exceed the base rent under the lease.
For example: On a lease with an annual base rent of $230,000.00, a requirement to pay turnover rent would be triggered once the gross sales exceed $230,001.00 in the relevant financial year.
We discuss turnover rent in further detail here.
If you are receiving a rent reduction as a commercial lease incentive, then the Landlord will require this to be documented in a separate deed. The lease will contain the unreduced rent or ‘the face rent‘. This is the rent that, in most states, is a matter of public record. Landlord’s require a veil be placed over these commercial lease incentive amounts for a variety of reasons. Including for valuation purposes and keeping the details confidential from other Tenants or potential Tenants.
A Landlord incentive or rent reduction is offered to Tenants as an enticement to make a deal. These can be structured a variety of ways:
- A fitout contribution: Landlord contributes to the cost of the Tenant’s fitout. It can give rise to some complicated ownership issues.
- Rent reduction
- Rent free period
- Cash incentive: Following some common law changes in how these incentives are dealt with at a taxation level, they have become far less common.
Each commercial lease incentive structure has pros and cons. The right incentive structure greatly depends on individual circumstances. We discuss this further in our article ‘Lease Incentives’.
Outgoings are the costs incurred by the Landlord in owning and operating the centre. The amount that each Tenant is required to contribute to those outgoings is calculated on the area that its premises bares to the lettable area of the centre.
Marketing / Promotion Levy
Tenants are often required to contribute to the Landlord’s marketing costs. The rationale is that increased traffic to the centre is beneficial to each Tenant. This amount is usually a calculated as a percentage of the base rent. The Landlord is required to use the marketing fund to promote the centre through various advertising techniques. In most states / territories the Landlord must give Tenants an annual statement containing the details of the advertising expenditure.
Occupancy Cost Ratio
Ultimately, your occupancy cost ratio will determine the value of both the lease as an asset and your business. Furthermore, if you have multiple sites the occupancy cost ratio reveals the performance of that specific store.
Put simply, your occupancy cost ratio is the amount of your gross sales that are spent leasing the space, expressed as a percentage.
With the exception of large national or international brands, Tenants will be required to provide the Landlord with a bank guarantee. Specifically, a bank guarantee is a guarantee provided from your financier that it will give the Landlord a specific amount if you default in your obligations under the lease. The usual scenario for a Landlord drawing down on the bank guarantee is a failure to pay rent.
Generally, the guarantee required will be an amount equal to 3 months gross rent under the lease. However, this amount will ultimately be determined by the Landlord factoring in the size of your business and whether you are providing any personal guarantees.
Option to renew
If you have an option term under your lease it means that, should you elect to do so, you can renew your lease for the length of the option term. If you are not in default under the lease, and you comply with the notice provisions, then the Landlord must honour the option term. Typically, you need to exercise your right to an option term around 6-9 months prior to the expiry date of the initial term.
Negotiating a commercial lease renewal can be a lengthy and costly exercise. The benefit of an option term is that you are guaranteed a new lease on the same terms. Therefore, it’s a relatively straight forward exercise to document the option term.
You are on ‘holdover‘ if you continue to occupy the premises after the expiry date with the Landlord’s permission. A holdover effectively converts the lease to a monthly tenancy and either party can terminate on 30 days’ notice.
Early Termination (or ‘break clause’)
Sometimes Tenants can negotiate a right to terminate the lease prior to the expiry date, without penalty. The most common circumstance would be a failure to achieve a pre-determined gross sales threshold. Such a provision would conceptually operate as follows:
If the business doesn’t hit a targeted amount of gross sales within a certain period (e.g. the first two years of the lease term), then you can elect to terminate the lease without any compensation being payable to the Landlord.
If you are a Queensland retailer the Landlord may seek an equal termination right. This is because it is also beneficial to the Landlord as top performing retailers generate a higher income for the asset.
For retailers outside Queensland, an equal termination right is prevented by the retail legislation.
Your ‘make good’ obligations refer to how the lease requires you to hand back the premises to the Landlord at the end of the lease. It can be a costly exercise if you are required to carry out a full make-good. If you are taking possession of a premises ‘as is’ then make sure to review the make good obligations carefully to ensure that you are only required to hand back the premises in the same condition, rather than as a bare shell.
If you are not sure how to negotiate this provision or what your obligations should be under your specific circumstances, consult with a commercial Tenant advocate. This can be a particularly costly exercise if you get it wrong.
Assignment of Lease
Assigning your lease means that your rights and obligations under the lease are transferred to the third party. Usually an assignment will occur if you are selling your business or it is part of an early exit strategy.
Your right to assign the lease will be subject to the Landlord’s consent.
We provide a ‘how to guide’ on assigning your lease here, inclusive of how to avoid Landlord consent disputes.
If your lease contains a demolition clause, it effectively allows the Landlord to end your lease early if it decides to undertake development or repair works and it cannot carry out those works without demolishing your premises.
Landlords are reluctant to give up this right and remove such a clause from a lease, particularly if the lease term is longer than 3 years. However if the Landlord exercises this right, under retail legislation Tenants are entitled to compensation.
A relocation clause is similar to the demolition clause. If a Landlord requires vacant possession of your premises to carry out certain works, then it can relocate your business to an alternative premises in the centre.
If the Landlord carries out a redevelopment or other significant works, it can often lead to business interruption disputes. Ensure that you understand any redevelopment plans prior to entering into the lease. If the Landlord has any potential plans, it should be noted in the Lessor Disclosure Statement.
Liberty Leasing understand that key lease terms can be pure jargon to first time retailers. This makes it difficult for Tenants to negotiate and then manage their lease, without the assistance of Tenant Representation & Advisory Services.
This glossary should provide you with a preliminary base and move you forward in either negotiating or managing your lease over the term. If you require any assistance, you can always contact us on (07) 3359 8273 or book an appointment online with a Commercial Tenant Advocate here.