As a consequence office leasing agents continue to report lack lustre demand with building owners offering attractive incentives not only to lure new tenants but to also encourage existing tenants to renew current leases. Against this background some landlords refuse to acknowledge changes in market dynamics and remain inflexible in their dealings when negotiating commercial terms. The market however remains the final arbiter and does have a levelling effect. Whilst it may not always be possible to negotiate out unacceptable and indeed inequitable lease terms it is important to focus on “winning the war and not each battle” and viewing the overall desired outcome. The most obvious hurdles that have to be navigated include:-
1) Quoting Rents – Rents quoted by agents can be confusing and are typically far in excess of the true open market rental value or “effective rental value”. There is nothing necessarily misleading about such practice just that landlords like to keep the quoting rentals or “face rents” high to maintain the property investment values. To offset such vagaries in rental levels incentives in the form of rent free or capital contributions to fit out are offered. The issue here is that if you are not familiar with current market rental/incentive levels or indeed overlook such incentives the financial impact can be penal.
Current rental incentives offered in Melbourne at present range anywhere between 10-25% dependent upon the property and location.
2) Fixed rent reviews – Why is it office landlords insist upon artificially high annual rental increments in their leases? Current increments demanded range from 3.5% to 5% per annum when the consumer price index figure for the last financial year was only 1.2%. Here again the totality of the cash flow over the life cycle of the lease should be taken into account when considering respective options.
3) Market rent reviews – Why do lessors demand “ratchet clauses” in their market review lease provisions i.e. the rent when reviewed cannot be less than the rent paid for the previous year – it cannot go down! Landlords do not recognise rents may possibly fall in the future or annual increments such as discussed above can inflate rental levels above what may be the applicable market rent at the time of review. Furthermore other conditions are often be slipped in to the rent review provisions to ensure artificially high outcomes.
4) Increases in outgoings – this is a corker! If you are paying a gross rent (i.e. the total rent and building and statutory outgoings) charges are lumped together as one charge as opposed to being charged as separately distinct amounts. In many cases the gross rent quoted is not necessarily gross rent but a semi gross rent where the landlord will also seek reimbursement of increases in outgoings over a base year. If you were are not confused before, you might be now! Not only is the gross rental figure increased annually by the agreed rate say 4% (so you are effectively paying a fixed increment on the building and statutory charges whether or not they have increased) but also having to pay a proportion of any increment in building and statutory charges over the initial base year of the lease – a double whammy!
5) Make good – The liability placed upon the tenant to make good to the premises at the end of the lease can in some instances be heavily weighted in the building owner’s favour with requirements to recarpet and replace items as new. Careful regard is needed to such clauses which can be onerous not to mention inequitable.
6) The modern lease – Standard Law Institute and REIV leases have helped simplify the provisions of the commercial lease so it is relatively easy to understand. However the majority of CBD office landlords insist upon employing their own standard form of lease that in most cases can only be described as excessively long, heavily biased towards the building owner and in parts incomprehensible to the common man. Here again it is often advisable to review the standard form of lease before making any commitment.
These are just some of the issues faced in a negotiation in which the landlord may through convention often refuse to concede. Such practices are common across the industry so if negotiations become too difficult and you decide to move on to another option the same issues will most likely be confronted again. So what is the answer? Well there is no simple answer but as mentioned above the objective is to win the war. Therefore negotiate hard and recognise it may be necessary to concede a few battles along the way and seek some form of offset by negotiating a larger incentive. What is important however is to analyse the financial impact of the respective commercial terms over the life cycle of the lease taking into account any incentive negotiated in order to determine the best outcome for your organisation.
Chris Goodwin is the principal of Goodwin Property Advisory and can be contacted firstname.lastname@example.org.