When it comes to negotiating long-term commercial leases, it can require a fair amount of future planning. Rent review clauses are there to make sure rent remains in touch with the market and doesn’t leave a landlord trapped in a drastically undervalued financial position.
Here is the low-down on the different types of rent reviews:
The market review
Market rent reviews are the traditional way of reviewing rent. Rent is adjusted so that it reflects any changes in the market. In the widely used Auckland District Law Society (ADLS) lease, the new rent can be proposed up to three months prior to the rent review date, and as late as the next rent review date. Any rent increase can be back-dated up to three months after the rent review date; otherwise, any increase is payable from the notice date. Tenants will generally have 20 working days to dispute any proposed increase.
- The pros: rent keeps track with the property value and market conditions.
- The cons: valuations can sometimes be expensive, particularly in situations where a tenant disputes the adjustment.
The consumer price index review
In this situation, rent is increased in relation to the Consumer Price Index, which is a measure of inflation set by Statistics New Zealand. The ADLS lease provides a specific formula to calculate CPI increases – it does not allow rent to decrease.
- The pros: allows for a degree of certainty for both parties. No costly valuation is required. CPI reviews do not generally lead to disputes.
- The cons: CPI reviews simply provide for an increase in line with general inflation and do not consider changes in property value. Rent may become out of sync with the market.
The fixed-rent increase review
By far the simplest form of rent review. This method allows rent to be increased by a pre-determined amount on agreed dates. While this offers simplicity and certainty for both parties, as with CPI reviews, it does not factor in unplanned changes in the market (such as recessions or any pandemics like Covid) and can lead to rent at odds with market value.
The turnover review
Using this method, rent is paid based on a percentage of the turnover of the business. This type of rental is less common here in New Zealand but is sometimes adopted by motels and retail premises. Landlords benefit if the tenant business is successful, and tenants can receive assistance in tougher times. This type of review could work well for landlords who are looking to assist new businesses and can be done in combination with another form of review that takes over once the business reaches certain milestones.
The combination review
It is not uncommon to see several different review methods included in a lease. It can reduce the potential negative factors found in some individual methods.
Combining occasional market rent reviews with a CPI regime is common and keeps the rent adjustments in step with the market. But these need to be administered carefully to avoid any large sudden changes in rent.
Ratchet clauses
Rent reviews can, in theory, lead to a reduction in rent, so to avoid this, landlords often include ratchet clauses to limit the degree that rent can reduce in any given review.
Hard ratchet: This clause only allows the rent to increase and rent cannot decrease below the previous amount payable.
Soft ratchet: The rent can decrease because of the rent review but never below a set figure – which is generally the rent at the start of the current lease term.
Every commercial lease is different, and some methods of review may not suit particular situations. Landlords and tenants will often have different views on which method is most favourable. But, as with all parts of a lease, this can be negotiated.
We always recommend getting legal advice when arranging a commercial lease to ensure it’s tailored to your unique circumstances and has all the appropriate clauses included.