Why Business Tenants Should Proceed with Caution

Written by Michael Smyth on Business Blogs.  See original HERE

Why Business Tenants should proceed with caution

With commercial vacancies in New Zealand’s main commercial centres tipped to go above 10%, many businesses may be tempted to get bigger or better premises, or open up new offices to take advantage of lower rents. However, the future has never been more uncertain than in the current economic downturn and businesses are well advised to look carefully before signing any documents which could ultimately spell financial disaster later on.

Know your documents

Before signing any document, you must understand what you are signing. Do not rely on the word of a Real Estate agent who may tell you that “its standard and everyone signs”.

If you are going into business premises there are two types of documents which you could be asked to sign: a lease and an agreement to lease. A lease is a contract between you and your landlord which sets out all the terms you have agreed relating to how that lease will operate. An agreement to lease on the other hand, is simply an agreement that you will enter into a full lease agreement at a later date. Since it is not a full lease, the agreement to lease does not contain all the terms you will later be agreeing to. By signing an agreement to lease document you may be committing yourself to signing a lease which works against you and in favour of the landlord. Therefore, it is important to get any agreement to lease document checked by a lawyer before you sign. If you don’t, then it may make it extremely difficult for you to extract yourself from onerous lease terms later on.

What onerous terms should you look out for?

There are a number of clauses in a typical or standard lease agreement which you should watch out for and negotiate. The first issue you should consider in the length or term of the lease. Don’t be persuaded into entering a long term such as six years without the ability to get out of the lease early if you need to. In the current economic climate you need the flexibility to bail out in case business goes bad. If you have committed to a long term then you remain liable for the rent whether you are in occupancy or not.

If you set up a separate company to take the lease, you may not think that will avoid the risk but it is likely your landlord will ask for a Director’s or Shareholder’s guarantee. This makes you, the business owner, personally liable if the company doesn’t pay. The same could apply if you assign the lease to another business and it doesn’t pay.

An assignment may not solve your problems either

When you “assign” a lease, you sell it to another party so that they become the tenant for the remainder of the lease term. You would think that this would absolve you of a liability to pay rent, but not necessarily. Many lease agreements provide that the original tenant (and guarantor) remain liable for the rent regardless of any assignment to a third party. Therefore, if the third party defaults on the rent, the landlord may come after you. Clearly this is undesirable so you need to negotiate these clauses to absolve you of any liability. If you don’t, you will not only end up liable for the rent which you originally agreed but also any rent increases that occur during the term… which brings me to my next point.

Will any rent increases be fair?

Beware of what are commonly called “rent ratchet clauses”. These are clauses which automatically increase the rent at given review points regardless of what the market is doing. Such clauses could mean that you end up paying greater than market rent which is very undesirable. Rent reviews in themselves are normal but they should be based upon market rent and not on some arbitrary figure. Therefore, pay close scrutiny to how these clauses are drafted.

Of course, the obligation to pay rent will just be one of many tenant obligations contained in the lease and care should be given to ensure that the remaining obligations are also not too onerous. For example, the obligation to maintain the premises will fall upon the tenant but you must ensure that they are not too wide. Also make sure that you have budgeted for other costs such as rates, insurance premiums, rubbish collection etc. One cost which sometimes catches tenants out is the obligation to pay the landlord’s solicitors’ costs for preparing the lease. Make sure you find out what these costs are (and negotiate them down) before you proceed.

Always Proceed with caution

Needless to say, lease agreements require careful reading before you sign on the dotted line. Few business owners will be qualified to do this without expert advice which is where your solicitor should come in. Always run these documents past your lawyer first and never rely on the advice of a real estate agent, otherwise your business could end up with a weight around its neck which in turn could spell financial disaster for you and your business.