Commercial Property Rent Review: a Brief Overview

Commercial property rent review clauses are standard in almost all commercial or retail property leases. This clause(s) outline how the rent will be increased once every year and at the start of a new term (if any). Some lessors and lessees may find these provisions complex and difficult to comprehend.

If a thorough evaluation of the rent amount and how it can vary throughout the term of the lease is not carried out, entering into a lease can be risky.

There are three common methods for a commercial property rent review, namely:

(1)  Fixed Percentage Increase

A commercial property rent review based on a fixed percentage increase is a set rent increase that occurs on specific times during the lease term, known as a "fixed percentage increase review." This usually happens on the anniversary of the lease's start date. In practical terms, this means that every year on the anniversary of the commencement date, the rent will rise by the amount of the fixed review. This sum typically ranges from two to five percent of the current annual rent.

(2)  Increase Based on the Consumer Price Index (CPI)

A commercial property rent review based on the consumer price index (CPI) is directly related with changes in the CPI which is a measure of inflation. It is implemented in accordance with an arithmetic formula found in the lease that is usually based on the city or state where the premises are located. The CPI for each Australian location is published by the Australia Bureau of Statistics (ABS).

(3)  Market Rent Review

A market rent review means that the rent for a property will adjust to reflect the state of the market. Typically, market rent reviews are not carried out during the lease term. If the lease has an option for a further term(s), a market rent review will usually occur if the lessee decides to exercise the option. This will kick off the provisions for market rent review, allowing the rent to be "reset" to match the market at the start of the subsequent term.

However, some landlords would insert a "ratchet clause" in the lease to prevent market declines. This provision states that the reviewed rent cannot be less than the rent in the current term. Ratchet provisions in retail leases are prohibited by Australian law. Commercial leases, however, do not contain such prohibition.

Pros & Cons of the 3 Commercial Property Rent Review Methods

(1)  Fixed Percentage Increase

Pros

A fixed rent increase is usually simple to calculate and impose. There is therefore limited room for disagreements. On each of the dates mentioned, the predetermined percentage increase is automatically applied.

A commercial property rent review with a fixed percentage increase also gives the lessee and lessor security. Both can budget accordingly because they are fully aware of the annual rent increases.

Cons

If the rent at the start of a lease was a high fixed rate or if an inherited lease has a high fixed rate (transferred from the previous owner of the business that was purchased), a costly situation would arise for the lessee. The lessee could try to negotiate a lower percentage rent rate. However, market forces (that is, supply and demand) will typically determine the final rent amount. Currently, a percentage rent increase rate could range from 2% (which is about equal to the consumer price index) and 5% (which is on the high side of the market). This applies to a lessor who finds that the annual fixed increases are below market rental rates.

Another drawback of a fixed rent increase is that rent may increase disproportionately to the growth of the business if the economy undergoes a downturn or recession when a high rate of increase is paid (for example, 5%).

Another drawback is that if there is an economic slowdown or a recession at the time the lessee is paying a high rate (example 5%), the rent may increase disproportionately to the growth of the lessee's business

(2)  Increase based on the Consumer Price Index (CPI)

Pros

The most equitable commercial property rent review method for a lessee is CPI. This is because the reviewed rent:

Cons

Most lessors with highly sought-after commercial properties would be hesitant to accept this approach. This is because it:

In order to deal with this, many lessors will either:

(3)  Market Rent Review

Pros

A market rent review may have advantages and disadvantages for both the lessor and lessee. This is due to the fact that market movements are unpredictable. Rents might go down if the market does not change or even declines. The rent will increase in line with the market, and it may even end up costing less overall than a fixed price increase. Additionally, rather than the lessor, an independent expert valuer often determines market rentals (unless the market rent has otherwise been agreed between the lessee and the lessor).

Cons

In some markets, the market rent can rise quickly, which would make budgeting for your rent more difficult. Additionally, any rapid growth in the market may result in rent that is substantially more than it was earlier. If the lease is to be assigned, this could also have consequences.

Additionally, determining the market rent can be expensive and time-consuming. The lessor or the lessor's agent will first conduct a market review and inform the lessee of the findings. If there is disagreement between the lessor and lessee with the lessor's review of the market rent, an independent professional valuer might be required to evaluate the results.  If an additional valuation is required, it will incur extra costs.

In some cases when the requested rent increase was modest, the expense of determining the market rent outweighs the advantage of the rent increase.

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Why appoint AskTheValuer for your Commercial Property Rent Review?

The rent review of your commercial property will be performed by the independent Principal Valuer @ AskTheValuer, a very experienced, skillful and knowledgeable professional who has done numerous such valuations in over 15 years. For more details about the valuer, go to <About>.