Understanding key lease terms can often assist both lessors and lessees to better grasp their lease entitlements and obligations in complex leases.
To assist you in better understanding your leases, we’ve outlined in this blog post some of the key terms that you will come across in most retail and other commercial leases.
Types of Rent:
Net Rent (or Base Rent
This is where all outgoings* are charged in addition to the rent.
This is where all outgoings are included in the rent.
This is where some outgoings are recoverable. Some examples of partial gross outgoings are:
- Increases over base
- Specific outgoings recovered (for example, electricity, rates)
*Outgoings do not include tenant specific charges that are billed directly to the tenant e.g Electricity
Turnover/Percentage Rent Calculation
This is where the lessee pays an additional rental amount based upon a percentage of their turnover, conditional upon achieving certain thresholds.
Percentage rent can be calculated in two ways:
Natural breakeven refers to the base rent equalling the percentage rent. The percentage rent threshold is calculated by:
Base Rent ÷ Turnover Rent Percentage = Turnover Threshold
E.g. $100,000 (Base Rent) ÷ 0.10% (Turnover Rent) = $1,000,000 (Turnover Threshold)
Turnover Rent of $1.1 million would be = ($1.1m – $1m) x 0.10% = $10,000 Turnover rent payable
Unnatural or Stepped
The threshold is set as a $ (dollar) amount e.g. the lessee will pay 2% above reaching $35 million. This is very common in Supermarket leases.
Fitout Rent (rare)
This is where the lessee pays rent back to the lessor in return for the lessor paying for the lessee’s fitout.
When the rent amount shown on the lease, which might not account for the outgoings or incentives within the lease.
When the rental amount after accounting for any lease incentives, as a calculation. For example, if a lessee gets six months’ rent free on a five-year lease (60 months) = 10% reduction on the face rent. So, if the face rent was $1,000/m2 the effective rent will be $900/m2.
Incentives are bonuses or discounts given to the lessee by the lessor at the start of the lease. They come in many forms including:
- Cash – Payment given to the lessee to be used for anything the lessee wishes.
- Contribution to Fitout – An amount given to the lessee to contribute to the cost of their fitout. Where the lessor contributes to the fitout of the premises, it is important to look carefully at your lease to see who owns the fitout on expiry of the lease.
- Rent Free Period – A period of time given to the lessee which is free from having to pay rent. This is usually a period of a few months at the beginning of the lease to cover fit out time or just as a general incentive.
This is an amount payable to the lessor to cover the costs of marketing the shopping centre. It is usually split between all lessees in a centre and calculated based on the square metre size that each lessee occupies.
This is a rebate paid to the lessee at the end of each year (either calendar year or financial year depending on the lessor) for any monies not used during the previous year from the Marketing/Promotion Levy paid.
The amount remaining in the Marketing/Promotion fund is split amongst each lessee based on the square metre size that each lessee occupies.
Occupancy Cost Ratio (OCR)
This calculation is used by lessees to measure the performance of the store in relation to a portfolio/industry benchmark.
There are two types of OCR:
Base Occupancy Cost
This is Base Rent ÷ Sales (Moving Annual Turnover (MAT))
E.g. $100,000 (Base Rent) ÷ $1,000,000 (Sales) = 10% OCR
Gross Occupancy Cost
This is Base Rent + Outgoings + Promotion Levy ÷ Sales or MAT
E.g. $1,200,000 (total of Base Rent, Outgoings and Promotion Levy ÷ $1,000,000 (Sales) = 12% Gross OCR
Security Deposit/Bank Guarantee
When signing most leases, a Security Deposit or Bank Guarantee may be required to be provided to the lessor by the lessee.
A Security Deposit is an amount of cash paid by the lessee to the lessor as security should the lessee default on the lease. A Bank Guarantee is an assurance from the lessee’s bank that the liabilities of the lease will be met by the lessee or the bank should the lessee default on the lease.
The Security Deposit or Bank Guarantee amount is usually calculated based on a number of months’ rent. For example, a lease with an annual base rent of $120,000 with a 2-month Security Deposit, would require the lessee to provide the lessor with $20,000 Security Deposit.
An option gives the lessee the right to renew their lease for a further term at the expiry of the original lease. The length and number of options may vary, depending on the lease, however a common option on a five-year lease would be 1 or 2 x 5-year option(s) on top of the original term.
Only lessees have the right to exercise the option to renew a lease and this must be done within what is called an Option Exercise Window. Usually this is between six and three months prior to the lease expiry, however this is dependent on the terms set out in the lease.
Should the lessee fail to notify the lessor of their intention to exercise their option within the Option Exercise Window, the option is voided and either the lessee must vacate the premises at the end of the original lease expiry or negotiate a new lease with new terms with the lessor.
Once the lease is expired and a new lease agreement is yet to be signed, a holdover clause allows the lessee to pay month-to-month. It also allows either the lessee or the lessor to terminate with 1-month notice.
Break Clause (aka Kickout Clause)
This allows the lessee to break the lease under certain conditions, usually involving a penalty.
It is usually conditional upon the lessee not achieving a certain sales outcome/s and occurs within a specified time frame within a lease.
This is the obligation of the lessee at expiry of the lease to return the premises to the condition that they leased it in, usually allowing for fair wear and tear.
Assignment (aka Alienation)
Assignment means that the lessee can sell the business or transfer it to another lessee, without penalty from the lessor.
This is usually conditional on a similar use operator with the same financial resources and skills as the existing lessee.
A demolition clause provides the right to terminate the lease by the lessor giving notice, usually 6 months, if they intend to demolish or redevelop the building.
This clause provides the lessor with the right to relocate the lessee to another part of the centre by giving notice and compensation. Usually the relocation is required to be in a comparable location.
Compensation can be anything form a rent-free period or abatement, to a reduction in rent during the relocation period.
An Abatement is compensation provided to the lessee from the lessor for any disruption in trading. Example may be building damage or damage to the tenancy that means that the lessee cannot trade or that trading may be reduced or impaired.
Another example may be that an anchor tenant is not trading in the centre as originally stated at the time of signing the lease within a certain time period. Therefore, the centre traffic would be lower and this in turn impairs the trading of the lessee.
Lease terms can be tricky to understand, thus increasing the difficulties in understanding your lease. Lessees and lessors generally seek extensive legal advice regarding lease entitlements and obligations, but this is both lengthy and expensive.
This post was authored by Simon Fonteyn. Simon is one of Australia’s leading experts in retail, childcare and medical leasing and rental valuations. He holds a Degree in Accounting & Finance, a Diploma of Valuation, a Masters of Management and is an Associate of the Australian Property Institute. With over 25 years experience in the commercial property industry, Simon founded LeaseInfo® as a way to provide more transparency to the industry.