Leasing commercial property for your Business

 

If you own a business, you will most likely, at some stage, have or will need to lease a commercial property for your business. Leasing a commercial property for your business can be a very costly and complicated experience. Proper, detailed planning and going through the correct process can benefit the long term.

You have spoken to your business adviser, and now you have your business plan and have found your ideal property in a prime location. What next? You need to understand many items when considering new premises for lease. Failure to fully understand the requirements of your contract could lead to complicated legal and costly financial implications at a later stage.

The main items to consider when leasing commercial premises for your business include:

Budget.

Have you researched your market and/or sought business advice on an ideal size and location for your large or small business? Leasing a commercial property for your business where you have to pay rent on a long-term basis is a significant expense. It can be one of the largest expenses for your business.
I have found that many businesses do not look at their business benchmarks. Let’s take the restaurant industry as an example. The average for profitable restaurants is around 8–12% of total sales. You can fairly accurately predict a struggle to remain profitable if rent is running at approximately 20% of turnover, unless they can increase sales to reduce this percentage.

Timeframe.

Locating your ideal premises can take a long time, especially in a tight market. Allowing yourself plenty of time to conduct your due diligence would be a good idea. Rushing your decision can result in a poor decision, ultimately affecting your business.

Location.

What is your ideal position? Knowing where your target customers are and their demographics, such as age and buying behaviours, can go a long way towards finding the right site. I have found that many business owners choose locations based on gut feelings. This can work sometimes. Working on a feasibility report with a business real estate specialist would significantly enhance the chances of finding the best location.

Permitted use of the property when leasing commercial property for your business

It is critical that the property be zoned for your particular business use. What is the current development approval for the premises? Find out if there are any government regulations that you need to comply with. Seek appropriate legal advice from your commercial real estate lawyer.

It is critical to check the current approval for your leasing premises. In my 35+ years in the commercial real estate and business brokerage business, I have found that some owners and tenants assume that the current use of premises is legal because the existing business has been operating there for many years. This can be a costly mistake. The council’s attitude is not so sympathetic. As far as they are concerned, that tenant has been operating illegally all that time.

It is recommended that you ask the property owner to provide you with the current approval notice for that area or building. You should then get your lawyer to confirm the use and advise if you need new approval for your intended purpose. Not doing so can be very costly down the track.

Actual rent.

The rent amount is usually the first thing you must negotiate with the landlord. It would probably be a good idea to have a good knowledge of competitive rents in the area to support your argument for a fair rent. More importantly, can your business support it?

Lease Terms

Term of Lease

Once you agree on the actual rent, the lease term is the next step. Moving your operations and/or fitting a new premise can be expensive. You must work out the best lease agreement term to justify starting costs or the cost of relocating there.

The length of the lease can be critical. It would be best if you considered your future options. For example, what if you wanted to move to a larger premises if that site was successful? Also, have you considered the situation when selling? The chances of getting a good price for your business becomes remote when there is little time on the lease.
The current owner might be very flexible with extending your lease when requested. Have you considered the situation if they decide to sell and you inherit a new owner who is not as flexible?

Rent-free periods

Landlords can offer long-term leases with rent-free periods. This is used as an incentive to allow you to establish yourself at the new premises. Many owners are reluctant to be generous with rent-free periods. They prefer to lower the rent without realising the effect on the property’s value. It could be worth considering the impact on the value of your property in a few years with a higher cap rate.

Option to extend

For example, if you are on a short-term lease, you may find yourself in a position where the landlord decides not to renew your lease. On the other hand, if your rental period is too long, you may have trouble assigning the contract to someone else if you outgrow the premises and need to move your business. For this reason, you should really think about how long your lease should be.

Rent reviews when leasing commercial property for your business

The majority of rent increases occur on an annual basis. Rent reviews can be calculated as follows:

CPI Increases

Most leases have Increases to correspond with the current consumer price index (CPI)

Fixed percentage increases

They are a fixed dollar amount increase

Market review rent.

Market review rent is when the increase in rent corresponds with the current market conditions for that type of commercial property. Additionally, when a market review rent is disputed, most leases allow for an independent valuer to be appointed to determine the new level.

Sometimes they may be a combination of more than one of these—for example, CPI plus a fixed percentage.

More importantly, these increases should be taken into account to ensure your business can afford them in the future.

Other leasing costs

Generally, there are other costs associated with the lease of the commercial premises.

They can include:

Outgoings and operating expenses

Outgoings and operating expenses are the landlord’s expenses in maintaining, repairing, and operating the leased premises. These costs include land tax, council rates, water rates, and general repairs. Security, cleaning of common areas, property maintenance, and building insurance

Commercial tenants usually pay outgoings as a percentage of the total floor area of their leased premises. Traditionally, this is termed the net rent form of payment. I.e., the tenant pays the basic rent plus a separate outgoing cost. Sometimes, the outgoings are estimated and paid as a lump sum with the rent. This is called gross rent. More details on gross versus net rent can be found in our article on gross versus net rent.

Insurance.

In addition to the building insurance paid as part of the outgoings to the landlord, most lessors insist that the lessee has a minimum level of public liability insurance and, in many cases, plate glass insurance.
Working with your insurance broker to ensure you are fully insured would be best.

Legal costs.

In general, these costs are usually agreed to with the landlord. Some types of leases, such as retail leases, may have different requirements for legal payments in some states. Your solicitor will usually outline your costs and obligations when negotiating your contract. If they don’t, I would suggest you ask them, as costs between lawyers could vary dramatically, and you could be in for a costly surprise.

Security Bond.

The bank guarantee or security bond depends on current business conditions, how difficult it is for the landlord to find a suitable tenant, and the possible risk you may face if you default on the lease. Generally, but not always, the more in demand or unique the premises are, the higher the bond. On the other hand, reputable businesses, such as large public companies and franchise operations, can usually negotiate a lower bond than a less-known business.
In my experience, I have found that the industry average is around three months. Major shopping centres and high-quality buildings can cost twice or more.

Refurbishment of premises.

Although these are more common in retail, many commercial leases have them. Under this clause, you must refurbish your premises within an agreed-upon period to a minimal professional level decided by the landlord during your lease. This could also include saying that you must “make good” on the premises. This make-good clause in the lease requires the tenant to present the premises in a similar condition to when the premises were initially leased.
You must understand when you are required to update your premises. Many leases have short periods of 3-5 years. Go through the terms with your commercial property specialist and lawyer to avoid surprises when leasing commercial property for your business.

Lease incentives

Sometimes, the landlord may offer extra incentives in slower economic times, such as contributing a certain amount of funds towards an initial fit-out or rent-free or discounted rent periods.
This should be seen as a win-win situation. The tenant gets a more pleasant premise to work from, and the landlord receives a higher rent and an increased capital value.
Let’s see how this would work.

Tenant looking at leasing retail space.

The current net rental is $4,500 per month, or $54,000 per year.

A new lease is offered as follows:
The landlord prepared to spend $150,000 upgrading the area
Rental quoted $6,000 per month, $72,000 per year
The rent increase was set at a fixed 5% per year

Now let’s look at the situation after 3 years.

Situation A –
Year 1: $54,000
Year 2: $56,700
Year 3: $59,535
Year 4: $62,512

Total rent: $232,747

Situation B
Year 1: $72,000
Year 2: $75,600
Year 3: $79,380
Year 4: $83,349

Total rent: $310,329

The net result for the commercial property owner

From the above, we will note that the landlord has spent $150,000 on improving the tenant’s area in year one. If they stuck to the old rent of the unfurbished premises, the rent collected over the first four years would be $232,747.

In situation B, the total rent collected over the first 4 years would be $310,329. The net amount would be $310,329 less $150,000 for the refurbishment, which is $160,329. So they are $72,418 worse off in rent collection over the four years.

At the same time, lets look at the increase in value of the property (assuming 5% cap rate)

Value at a cap rate of 5%
Situation A: $1,259,240
Situation B: $1,666,980

An increase of $407,740 in property value less $72,418 (rent shortfall over 4 years) equals a net gain (if they sold in 4 years) of $335,322. A nice capital gain on their $150,000 investment.

Repairs and maintenance

The tenant usually carries out the general maintenance and replacements required to keep your premises in excellent working condition.
It is essential to clearly state each party’s obligations in the commercial property lease to avoid any disputes.

Relocation and demolition clause

Relocation Clause

Relocation clauses are more common in shopping centre retail leases. Under this clause, the landlord can move the business owner to another location within the shopping centre at any time within the conditions and allocated time outlined in the contract. Often with little, if any, compensation. This clause is becoming more common in major shopping centres.

Demolition Clause.

A demolition clause is when the landlord can terminate the lease and vacate the premises for significant refurbishment or redevelopment within the short notice outlined in the contract.
Termination notice.
Some leases can have other conditions where the lessor can terminate your contract for any other reason on your commercial property.

Termination notice.

Some leases can have other conditions where the lessor can terminate your contract for any other reason on your commercial property.

Professional Advice.

The lease is an essential and binding contract between tenant and landlord. When considering a rental, it is recommended that you seek professional, specialist legal and business advice before;

Committing to any lease-related documents, such as a disclosure statement or signing to lease a commercial property

Committing to paying any deposit or any other monies

Taking possession of the premises

Carrying out any building work on the property.

Solicitor

Specifically, your solicitor will be able to make sure that your interests are protected and explain to you that there are no conditions or clauses that are illegal, unfair, or unreasonable. They can also clarify any costs or fees for which the tenant is responsible.

Accountant

An accountant can advise you on the financial aspects of the lease, including the rent and term best suited to your business and cash flow. They will also advise you on any tax implications, including GST and other items required by the Australian Taxation Office. Depending on your current business and financial position, buying commercial property can be a better long-term proposition.

Business Advisor

Your business advisor could actively assist you in understanding your business requirements for your lease, including information on regulatory requirements, type of lease, and location.

Conclusion

In conclusion, you need to do your market research when leasing commercial property for your business. Look around and see what the local conditions are. Your specialist commercial real estate agent with extensive experience in buying, selling, and leasing commercial business property should now have all your requirements to shortlist your ideal business property.

About the author

Written by Con Tastzidis
Con is the managing director of the multi-award-winning commercial real estate brokerage and consulting company CST Properties since 2001.
With over 40 years of hands-on experience, Con Tastzidis has etched an indelible mark in the hotel, tourism, leisure, commercial property, and business sectors. Having engaged with national and international hotel and property companies and owners, Con possesses a profound understanding of the intricate dynamics that drive success in this arena.

Con is the author of several books, including the Amazon top-selling book “Real Estate Investing For The Residential Investor-The- The 7 Myths of Commercial Real Estate Explained”. In this book, Con outlines many of the successful outcomes he has achieved in both good and adverse economic conditions for his clients. More importantly, how working with Con can work for you. Con has been featured in several national and international media outlets, including FOX, CBS, NBC, ABC, CNN, and BLOOMBERG.
If you would like to work with Con, he can be contacted through this link Feel free to contact Con Tastzidis at CST Properties.

Would you like to discuss this further? The contact Con Tastzidis on 02 9882 2221, 0403 118830, or by email at invest@www.cstproperties.com.