5 Things To Keep In Mind Before Entering a Commercial Lease
If you’re a business owner it is unlikely that a commercial lease is a foreign concept to you – businesses enter into them every day. Despite the fact it may seem like a simple thing to understand, signing a commercial lease is no trivial matter, in fact, many businesses find themselves in tricky and often avoidable spots when they rush into signing commercial leases.
What is a Commercial Lease?
A commercial lease is a binding contract between the owner of a commercial property and someone who wants use of it for a set period. Usually, we are talking about office space, shop fronts, factories, warehouses, or other places you might choose to run your business from. Once a commercial lease is signed, the lessee is obligated to comply with ALL the terms for the full term of the lease. Not something you want to rush into!
Noting this, we believe there are 5 questions you should ask yourself before signing a commercial lease.
1. Are the Premises Suitable for Your Needs?
Due-diligence is paramount when entering into any commercial lease. This should include things like understanding if the premises is well maintained, what’s included, what fit out would be required and whether it’s even possible, through to determining how it is zoned and whether your business can in fact operate there.
The truth is, not all premises will be suited to your proposed use. When considering a commercial lease, check with the local council to see how it is zoned and whether your business can operate from there. In the event it wasn’t zoned appropriately but you really loved the premises, you might consider lodging a development approval with the council to use the premises for your proposed use. This is a special condition that should be drafted into your lease so if your proposal is rejected by council, you are not bound by the lease.
Remember, if you have signed the lease without adding this condition and council rejects your proposal, you are still obligated to meet the terms of the lease (such as paying rent) even if your business can’t operate there!
Another important consideration is whether you have exclusive use within the building, land or area. This will prevent other businesses similar to your own from opening up next door and becoming your direct competition.
2. Do You Understand the Costs?
A commercial lease should be specific as to the costs but be sure to look out for what outgoings are noted in the agreement. It is a good idea to request a breakdown of the likely outgoings payable in addition to rent so you know what to expect.
It’s also important to understand how future rent is calculated. There are positives and negatives to the various methods of rent calculation. For example, market rent lets you take advantage of the turns in the market, but set increases or increases by CPI gives you more certainty for the future.
You should also watch out for “ratchet” rent review provisions as these are often included in commercial leases and means rent can increase at market review but cannot decrease.
You’ll want to know about that!
It is a good idea to seek financial advice around all the current and future costs of your commercial lease to ensure your business can afford it and you fully understand it.
3. Are there Incentives?
Often leases include incentives to entice tenants. This might look like a rent-free period, a rent reduction or a fit-out contribution. It is vital that any agreements, including side arrangements or ‘handshake’ deals, are clearly documented in the terms of the lease otherwise they are unlikely to be enforceable. Also, be aware that these incentives may have a payback provision in the lease requiring you to repay it after a particular event.
4. Will You Need to Provide a Personal Guarantee?
It may be that the landlord requests you provide a personal guarantee to provide them extra protection if you are unable to meet the costs.
Personal guarantees can be risky as they make you personally liable for any debts if your business is unable to pay.
There are some alternatives to signing a personal guarantee that you may like to consider and you can read about these in our previous article, 4 Myths Busted About Personal Guarantees.
5. Have You Sought Legal Advice?
This part is paramount! Any and every would-be lessee should always seek advice when contemplating a commercial lease given the large rental and outgoing outlay they will incur over the term of the lease, together with the possible fit-out costs and make-good provisions. Commercial leases can be complex and lengthy often running up to 50 pages. Having a lawyer read over and then explain the terms of lease and your exposure to you is crucial in protecting your interests and avoiding misunderstanding about your obligations under the lease.
Another reason to bring a lawyer on board is to help with negotiations – our clients are often surprised at how much wriggle room they have when negotiating favourable terms in their commercial lease. An experienced legal advisor can assist in negotiating key terms such as rent, options to renew, incentive terms, and more.
Please note we no longer offer Estate Planning and Business Law as part of our legal services. We would be happy to refer you to one of our referral partners.