It always blows my mind when I hear of a business owner trying to negotiate a commercial lease for their business with no prior experience nor knowledge of the complexities and depth involved in a due diligence checklist for a lease negotiation.
Leases are almost always in favour of the landlord, the ‘lessor’, so it’s critical you understand the terms of your agreement before you make a commitment. Trying to negotiate a commercial lease mid-term is almost impossible. You may have more luck in between terms but it’s still very difficult. What you may not know is that everything in the agreement is negotiable before you sign but once the agreement is finalised, you are legally locked in until the end of the term – which may be years – and the associated financial obligation could amount to hundreds of thousands of dollars.
We often see business owners engaging independent valuers when purchasing but not leasing, when really, they are often the same, if not riskier.
Let’s take a basic example of a five-year lease at $10,000 a month. This amounts to $600,000 over the term of the lease. That’s a lot of cash.
Unlike a property purchase which is an asset that can be sold if required, leases are complex and extremely tough to get out of. This is great protection for you in the event the landlord wants to increase your rent or develop the site but not so great if things change in your business and the lease terms become unfavourable or you can no longer afford the rent. If your business struggles, or the location doesn’t work, you are legally bound to the repayments until the term expires. And if business grows and prospers, the terms of the lease could choke you, especially when the vendor knows how important it is for you to keep your business location.
Starting a new business or expanding your operations always carries risk. Securing the best possible deal significantly reduces this risk and keeps more money in your pocket at a critical time. It’s important your new lease or renewal aligns with your business goals and activities to ensure it remains financially sustainable for the duration of the agreement.
If you’re about to go head to head with an agent or landlord, I would strongly advise you to get the support of a trusted lawyer or advocate to ensure:
If you’re game enough to negotiate the terms independently, here are the first five of my top ten tips to help you navigate the process so you get the best outcome for your business.
Know your value as a medical tenant and know when to use it
Put yourself in the shoes of a landlord. What would you look for? A landlord wants a tenant with a successful business that has high demand, longevity and ethical practices. A property with a medical tenant has status and is of higher value to the landlord than if it was occupied by a business that carries more risk such as a café or boutique retailer. As a medical tenant, you have leverage so use it in your discussions, especially in the early stages when they are trying to ‘court’ you.
You’ll often hear agents say: “It’s a standard lease.” Let me tell you, even standard leases are not your friend and you can definitely negotiate better terms, especially since you’re not a “standard” tenant.
Get to know the leasing agent and vendor situation; find out what’s important to them well before you start talking terms and price.
Understand the concept of ‘Face Rent’ versus ‘Effective Rent’
There are two types of rental payments in a negotiation – Face Rent and Effective Rent – something many first-time negotiators are unaware of. Face Rent is the landlord’s official asking price and Effective Rent is the amount you pay post negotiations, hopefully a lot less!
Every dollar that is reduced from the monthly fee diminishes the value of the asset so the landlord will be loath to discount the rent. However, getting the landlord to make contributions or including rent free periods to sweeten the deal are easier to obtain. By seeking a monthly ‘abatement’ (an amount that is paid back to you each month) you are able to allow the landlord to protect the official value of the building, but also achieve a lower monthly rent.
Once you have negotiated a great deal, you need to protect it. Fixed increases to the effective rent are crucial and ensure any increases are made to the reduced rent and not the original asking rent. We like a bit of everything so always ask for all kinds of concessions before you agree to the payment terms.
Research the local market
You must know the market as well as the agent with whom you are dealing. Recently leased sites and any terms they achieved will be used in negotiations. Knowing how these sites compare to yours will ensure you don’t get overloaded with information and sold based on sites that are inferior.
Ensure you are the owner of the site fit-out
Whether you’re establishing a new business or expanding, the fit-out and refurbishing costs can be steep. Factoring in a contribution from the landlord to lighten this load, and making the premises more attractive to a prospective medical tenant, is a smart move. But keep in mind the lessor may request you leave behind any improvements made to the site upon vacating. Depending on your reason for leaving, vacating a fully fitted-out site could open you up to a competitor seamlessly transitioning into your established location…to the extreme joy and satisfaction of the landlord, especially if the relationship has broken down (which unfortunately is often the case).
Familiarise yourself with the rules of strata sites
If you are considering a move to a strata site, speak with the body corporate to make sure your business can operate from that specific site. Do you need to install specialist equipment that requires certain plumbing, insulation or electrical work which they need to approve? Make sure you include a clause that allows you to exit the agreement if this isn’t approved on the body corporate side.
The due diligence list for a lease negotiation is extensive and one of the most complex pieces of work we engage in. Go into your negotiations with your eyes wide open and scrutinise all items in the agreement.
Get in touch with us for some independent advice and stay tuned for Part 2 where I’ll give you a further five tips to help you get the best outcome from your negotiations.