Understanding Common Terms and Conditions in Commercial Leasing
There is a lot of legal jargon involved in the commercial leasing process that, understandably, not all potential tenants and landlords will be familiar with. In this article, I aim to explain what all of these terms mean in one place that you can refer to when in doubt.
Some of these terms and conditions have their own Signus Legal blog posts dedicated to explaining them in detail. I will include links to those articles if you need an explanation of a concept in more depth.
- Lease Term and Renewal Options
The lease term is the duration for which the lease is valid, i.e., how long the tenant is legally allowed to occupy the property. Lease terms typically range from three to ten years in Australia, though the option to renew the lease is sometimes available. Tenants must notify the landlord of their intent to renew the lease within a contractually agreed-upon timeframe, often 3 to 6 months before the lease is scheduled to expire. This timeframe is known as an ‘option period.’
- Rent Reviews
Rent reviews are meetings in which the price of rent is reviewed in order to properly reflect market fluctuation. The times in which this occurs and the circumstances that would warrant a review are agreed by the landlord and tenant before the lease is signed. I explain rent reviews in greater depth in this article.
- Outgoings
Outgoing costs are expenses associated with the operation of a property that are typically paid by the landlord and then recovered from the tenant. They may include council rates, utilities, insurance premiums, strata levies, maintenance and land tax. Careful review of the outgoings and their potential for cost increases is vital to budget management and risk mitigation. We have a more detailed guide to outgoings here.
- Security Deposit / Bond
A security deposit is a one-time payment or guarantee that a tenant provides to the landlord at the start of the lease to protect the landlord should the tenant fail to meet their contractual obligations. It is typically equivalent to three months of rent and is returned to the tenant at the end of the lease if the tenant has met all obligations and the landlord has not needed to apply it. A security deposit typically comes in two different forms: a cash bond or a bank guarantee. Our post here explains the differences between them and which is right for you.
- Make-Good Provisions
Make-good obligations specify the condition in which the tenant must leave the property at the end of their lease. These obligations can include repairing any damage, restoring the property to its original condition (called the ‘bare shell’ or ‘base building condition’) and removing any tenant-installed fixtures or fittings. For more information, read our article here.
- Repair and Maintenance Obligations
The lease will specify who is responsible for repairs and maintenance including structural repairs, utilities, compliance with building regulations and addressing fair wear-and-tear. Typically, the landlord is responsible for the long-term structural upkeep of the property while the tenant is responsible for day-to-day maintenance, utilities and repairing any damage caused by the tenant’s use. Each party’s obligations to address and pay for maintenance is a common area of dispute, so proper conversation before the lease begins is crucial.
- Subleases and Assignment of Lease
A sublease is when a tenant rents part or all of the leased premises to another person, known as the subtenant. In a sublease, the original tenant (sublessor) still maintains their obligations to the landlord and remains responsible for all of the subtenant’s actions. An assignment is when the original tenant transfers the property and all of their rights and obligations to a new tenant. These concepts are explained in more detail in this article.
- Default and Termination
A lease default occurs when a tenant fails to meet their contractual obligations, such as non-payment of rent or breach of lease covenants. The landlord typically issues a notice of default, and the tenant then usually has a grace period (often specified in the lease) to remedy the breach before the landlord can legally terminate the lease. Understanding default provisions is crucial to avoiding unwanted forced termination. Additionally, where the lease includes a break clause, a tenant may terminate a fixed-term lease early by exercising this option, which typically requires advance notice and may involve paying a break fee.
- Permitted Use
Permitted use clauses specify how the tenant is permitted to use the leased premises. Tenants should be completely transparent with the landlord about their intended use of the property and seek approval for any changes to the permitted use. Our post here provides more information.
- Insurance Requirements
Insurance requirements and associated costs are often overlooked in tenant budgeting. Tenants are usually required to hold public liability insurance, with minimum coverage amounts specified in the lease. The tenant’s insurance should be arranged with reference to the landlord’s building insurance to ensure the two policies work together with no coverage gaps.
- Personal Guarantees
When the tenant is a company rather than an individual, landlords often require personal guarantees from the directors. These guarantees create personal liability to pay rent, outgoings and damages if the company defaults. Like security deposits, personal guarantees are designed to protect the landlord from financial loss if the tenant company fails to meet its obligations. Landlords and tenants need to discuss negotiating caps, release mechanisms and whether specific obligations can be limited before the lease is signed.
Final Advice
When preparing your budget for lease commencement, consider the terms and conditions discussed above to ensure you have accounted for all expenses associated with the lease, including outgoings, insurance, and any fit-out or make-good costs.
If you have any questions about commercial lease terms and conditions or need assistance with lease negotiation or review, please do not hesitate to contact us.
DISCLAIMER: This article is for informational purposes only and does not constitute legal advice.