Ten tips to take into your next commercial lease negotiations

Lease Negotiation
Julian Muldoon

Julian Muldoon

Director of 1Group Property Advisory

Buying or starting a business is probably one of the most life changing and significant ventures you’ll undertake in your life. It’s up there with buying your first home, having your first child, getting married or getting divorced. It’s really hard work. But when you find the right site and you can visualise yourself, your staff and clients operating in that space, it’s pretty thrilling. After the initial transition into the new premises, when you begin to find your groove and your business begins to thrive, it makes all the effort you put into searching for the right site worth it. But what if your business changes? Or you change? Or you want to expand or sell? Does the lease agreement you signed all those months, or even years ago, accommodate that?

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.

Here’s why:

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.

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:

  • the lease is not heavily weighted in the lessor’s favour; and
  • the terminology in the lease is not open to interpretation.

 

Some common terms and conditions that you need to look out for in a lease agreement.

 

If you’re game enough to negotiate the terms independently, here are my top ten tips to help you navigate the process so you get the best outcome for your business.

 

  1. 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.

     

  2. Make sure you get the right site

    This seems like a really obvious one but this step involves much more than finding a location with great exposure and high foot traffic. It’s also extremely time consuming and will be a day in day out exercise requiring a lot of expertise and discretion.

    The site you’re considering may be occupied by a competitor, or the agent could know your current landlord or boss. If they knew you were looking to take over the site, would that have an impact on your own business?

    What’s the implication of your current leasing agent knowing your circumstances? If there’s plentiful supply of sites that are right for your practice, this may put you in a better position to re-negotiate terms with your current landlord – or not if suitable sites are scarce.

    Does the vendor of the prospective site know your circumstances? If they know they have the only available site that meets your requirements, your bargaining power is greatly diminished.

    I’ve also found some business owners are too narrow with the search and miss opportunities in neighbouring suburbs. Additionally, they’ll go for sites that are larger – or in some cases smaller – than what they actually need. Does the site allow for your business to grow and expand? What are your blind spots?

    My recommendation is to outsource this process to an expert so you can focus on your customers through the transition.

     

  3. 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 ensures 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.

     

  4. Check if your contract includes a ‘Development Clause’

    Most of our clients are engaging in expensive, specialists fit outs with the intent to stay at the current location for long periods of time. A development clause is often inserted by the vendor to allow them to sell or develop the site should it present as a lucrative option or when they can make a high margin on a sale.

    For your own protection, it’s best to have this clause removed at least for the first term (if not two terms) to ensure you’re not forced out of the premises after you’ve invested a lot of cash in a fit-out and time building your profile. Alternatively, you can negotiate compensation for relocation costs, loss of business and goodwill, and a financial contribution to the fit-out at the new premises.

     

  5. Make sure you are allowed to assign or sub-let the site

    Assigning the lease means the lease is taken on by another party. This is an alternative to ending a lease before the agreed duration of tenancy for which you are financially liable. You may need to do this if you decide to sell your business or can no longer keep operating. If this is the case, you will need the permission of the landlord so make sure your lease states they cannot unreasonably withhold their consent. This is very important if you are looking at a 'scale and sell’ business model.

    Similarly, if you sub-let part or all of your premises, you are still liable for the lease until the end of the term. This means you must pay the full rent even if your incoming tenant fails to pay. It is important to undertake a credit check and ensure that the incoming tenant is able to meet the lease requirements.

    Keep in mind if you are assigning a lease or sub-letting, you may be required to pay the landlord’s reasonable legal costs and other associated expenses.

     

  6. 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.

     

  7. Know who is responsible for the maintenance of an ageing building

    With many older residential or heritage properties being converted into medical and health centres, veterinary clinics or dental practices, we are often seeing these buildings begin to deteriorate and become unsafe. The maintenance and general upkeep of these ageing buildings requires significant investment that, in some cases, the landlord is reluctant to provide.

    If your lease is negotiated properly, the landlord is responsible for the structure of the building and major capital items (i.e. roof, walls, air-conditioner, exterior fittings such as gutters and downpipes, plant and equipment that is the property of the landlord, etc). If your building is not compliant with state government legislation, the lessor could be in breach. Obtaining an independent building inspection will help you understand the severity of the issues so you can enforce renovation, maintenance or possibly renegotiate your lease.

     

  8. Ensure you are the owner of the site fitout

    Whether establishing a new business or expanding, the fitout 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).

     

  9. 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.

     

  10. Check your ‘heads of agreement’

    Leasing agents work hard to get a result and are commission-based operators just like sales agents which is why a Heads of Agreement comes in handy. A Heads of Agreement document is drafted for review prior to the lease agreement so both parties can review the terms. It is usually non-binding and is like an overview of the key terms that are set out in the actual contract. Always run the Heads of Agreement past your solicitor before signing and ensure they are not trying to lock you in at this early stage with a non-refundable deposit.

     

Just like you wouldn’t recommend your clients treat their health and medical issues without proper advice, we at 1Group would always recommend you get the right advice and support from a trusted adviser or tenant representative before you accept a long-term lease agreement. Get in touch with us to find out how we can negotiate the right terms on your behalf to mitigate risk and optimise margins, while keeping your profile confidential until the time is right.

 

 

Disclaimer: This article may contain errors or omission and in some parts represents only the opinion of the author or information obtained from third parties. The article does not constitute legal and/or financial advice and should not be relied on as such. Individuals are recommended to obtain independent professional advice if they have any concerns about the content of this article. This article remains the property of 1Group Property Advisory Pty Ltd and shall not be copied, reproduced or represented without permission of the author.


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