Commercial Leases NZ
A commercial lease is usually the second largest commitment a small business makes, after wages, and it is signed with far less scrutiny than a mortgage a tenth of the size. Three features do most of the damage, and none of them is hidden. They are simply in a document nobody read closely.
They are operating expenses, the ratchet clause, and the personal guarantee.
The three things to remember
The advertised rent is not the occupancy cost. A ratchet means rent never goes down. And a personal guarantee undoes the limited liability your company was set up for.
Operating expenses are on top
Commercial space is usually advertised as a rate per square metre per annum for base rent. Outgoings, commonly called opex, are charged separately: rates, building insurance, maintenance, management fees, common area costs and often more.
Take 200 square metres advertised at $350.00 per square metre, with opex of $90.00 per square metre.
Base rent changes only at review. Outgoings change whenever the underlying costs change, and rates and insurance have both moved sharply in recent years. Unless the lease caps opex or excludes specified categories, a tenant carries that movement in full. Ask for the last three years of actual outgoings for the building, not the estimate, and ask what is included in management fees.
The ratchet clause
At a market rent review, an independent assessment establishes what the space is worth. A ratchet clause provides that the new rent cannot be less than the rent currently payable.
So the review is one-directional. If the market has risen, the rent rises. If the market has fallen, the rent stays where it is. You never get the benefit of a soft market, but you always carry a strong one.
A ratchet is not a law of nature. Depending on the market and your bargaining position you may be able to remove it, soften it to a floor at the original rent rather than the current one, or trade it for something else such as a longer term or a rent-free fit-out period. It is very hard to negotiate after signing and quite often possible before. Landlords expect the request from a represented tenant.
The other review types
| Review type | How the new rent is set |
|---|---|
| Market review | An assessment of comparable space, subject to any ratchet |
| CPI review | Adjusted by movement in the consumers price index |
| Fixed percentage review | A stated increase, often 2 to 4 percent, regardless of the market |
A fixed percentage review is the easiest to model and the least forgiving. It rises on schedule whether or not your revenue does, and whether or not the market supports it.
The personal guarantee
Most small businesses trade through a limited liability company, and the point of that structure is that the company's obligations are the company's. A personal guarantee on the lease removes that protection for the largest obligation the company has.
If the business fails, the landlord can pursue the guarantors personally for the remaining rent. Not the fit-out or the stock. The rent, for the balance of the term, which on a six year lease at $88,000.00 a year is a very large number attached to a house.
When a lease is assigned to a buyer of your business, the outgoing tenant and its guarantors commonly remain liable if the incoming tenant defaults. You can sell up, walk away, and still be pursued for rent on premises you no longer occupy, run by someone you no longer know. Whether a release is available is a negotiation at assignment, and the time to think about it is at signing.
Two clauses worth finding before you sign
The first is reinstatement, sometimes called make good. At the end of the term you may be required to remove your fit-out and return the premises to their original condition. On a fitted-out retail or hospitality site that is a substantial cost arriving exactly when the business is closing or moving, which is when it can least be afforded.
The second is the no-access provision. The standard deed of lease was amended to address situations where an emergency prevents a tenant from accessing the premises, providing for a fair proportion of rent and outgoings to cease to be payable. Whether your lease contains it, and in what form, is worth checking rather than assuming, because deeds in circulation differ.
Before you sign
What this guide does not cover
Lease terms are negotiable and vary widely, and the deed in front of you may be amended from the standard form in ways that change its effect substantially. Rent review mechanics, dispute procedures, subleasing, GST on outgoings, and the tax treatment of lease incentives all require specific advice. This is general information rather than legal advice, and a property lawyer should review any commercial lease before you sign it or give a personal guarantee.
Related guides and tools
- Business structure basics guide, for the limited liability a personal guarantee gives away.
- Buying a franchise guide, for the franchise that often comes bundled with the lease.
- GST registration guide, for how GST applies to rent and outgoings.
- Debt service ratio guide, for how fixed commitments read to a lender.
- Business depreciation guide, for the fit-out you may have to remove at the end.
Test Your Knowledge
Ten questions on commercial lease costs and clauses.
Sources: the Auckland District Law Society deed of lease, which is the standard form in general use in New Zealand; the Property Law Act 2007; and general contract law. Lease terms are negotiable and vary, and the deed in front of you may be amended from the standard form in ways that matter. This is general information rather than legal advice, and a property lawyer should review any commercial lease before you sign it or give a personal guarantee.
Related tools and guides
- Buy vs lease premises calculator: the annual cost of owning against leasing.
- Business cash buffer calculator: the reserve a lease commitment demands.