It is my experience in recent times, that due to a tightening of the credit market and in the wake of the recent Banking Royal Commission, there has been increased scrutiny over the performance of assets which form security for finance. This is particularly the case for property, which has fallen out of favour with financiers.
Therefore, an appropriate rental return is vital – more than ever before – and it should be carefully monitored to avoid the value of your property failing your financier’s credit criteria. If you are a landlord that has a property portfolio financed, you can expect that your financier will look closely at rental returns.
Consequently, it is critical to carefully consider the basis on which your rent is being determined and the circumstances in which valuations can be challenged.
Methods of Rental Review
There are several methods of determining rent review for retail and commercial leases:
- Fixed Percentage Increase Review: As the name suggests, this method of rental review is based on a fixed increase in rent on specified dates during the term of your lease. The percentage will generally vary depending on the location and type of premises.
- Consumer Price Index: A CPI rent review follows changes in the Consumer Price Index, which is calculated quarterly by the ABS. Essentially, the rent will increase by the same percentage as the CPI.
- Market Rent Review: A market rent review allows for a market valuation of rent. Usually the parties will have an opportunity to negotiate, failing which an independent valuer is appointed.
The Legislative Landscape in NSW
In NSW, the process of rental review for retail leases is governed by the Retail Leases Act (the Act). The objective of the Act is to safeguard a tenant’s interest.
The effect of the legislation is as follows:
- The current market rent is the rent that would reasonably be expected to be paid for the premises, taking into account rent paid for similar premises, rental concessions and gross rent less the landlord’s outgoings payable by the tenant.
- If the parties cannot agree on the actual amount of rent, then a special retail valuer can be appointed to make this determination.
Operation of S32 of the Act
One of my favourites is Section 32 of the Act, which allows the tenant the opportunity to have current market rent determined early. The provision states:
a) The tenant is entitled to request a determination of market rent at any time that begins six months before and ends three months before the last day on which the option to renew may be exercised under the lease;
b) The tenant makes the request by giving notice, in writing to the landlord;
c) The tenant must exercise their option within 21 days after determination of rent is made and notified to the tenant; and,
d) Parties to the lease share costs of valuation of market rent in equal shares.
Effectively, the tenant has the right to request a determination of market rent before the date of exercise of option, which then affords them the opportunity to make an informed decision as to whether to exercise their option to renew.
Data Base Corporate Pty Ltd v Strike Australia Pty Ltd [2019] NSWSC 379
A recent decision of the NSW Supreme Court demonstrates the importance of perusing a valuer’s review of market rent to ensure it complies with the terms of your lease. The facts of the case were as follows:
- Data Base Corporate Pty Ltd was the sub-lessor and Strike Australia Pty Ltd was the sub-lessee;
- The premises was located at the King St Wharf Complex and utilised as a bowling alley;
- The lease provided that rent for a subsequent term would be market rent, determined by an independent valuer; and,
- Clause 4.5 of the sublease stated the valuer was to “have regard to…market rents…for comparable premises in the vicinity of the premises.” The valuer examined the rent of similar bowling venues in Macquarie Park (17km away) and Bondi Beach (10km away).
The NSW Supreme Court decided that this valuation was inconsistent with the terms of the lease because the comparable premises were not within “the vicinity of the premises.”
Key Takeaways from this Decision
In an era of increased scrutiny over the performance of securitised assets, the rental valuation of your lease is of utmost importance. As was the case in the above decision, you may be able to contest the valuation.
I recommend that you carefully consider the basis on which the rent for your lease is being valued. It is vital that you understand the terms of rental review provisions and I would be happy to guide you in making sense of these complex terms:
