Understanding the rent review clause in commercial property leases

One of the largest expenses facing a business is the monthly rental for its premises. Due to the nature of commercial leases which usually run for lengthy periods of time, it is essential for commercial tenants to understand all the factors that could effect their future obligations as outlined in the contract.

The provision of a rent review clause in commercial property leases is common practice amongst landlords and tenants worldwide. Essentially, the intention is for both parties to secure a long lease and at the same time ensure rentals are re-aligned to market levels at agreed intervals.

“In South Africa’s inflationary environment, these are typically set at 5 yearly reviews.  The incidence of ‘ratchet’ clauses – preventing the renewal rental from falling below the rent under review, is a practice which undermines the purpose of the review terms and tenants who have signed and fallen foul of this provision have only themselves to blame,” explains Martin Fitchet, Director of Knight Frank.

The review provision commonly prescribes 3 processes; FIRST - that the renewal rental and escalation be agreed between the parties; SECOND, that failing agreement, the parties agree either – to separately nominate their own expert with provision for the experts to agree, – and further failing agreement between the experts then THIRDLY, a 3rd party expert or arbiter is introduced to review and rule on the experts’ opinions, the outcome being binding on the lease parties. “In the second part, there may alternatively be provision for the parties to agree on the joint appointment of a single expert whose findings will be binding on both. In this instance, there is no need to default to the 3rd process of arbitration,” confirms Fitchet.

He continues, “The lease provisions are thus clear. It gets murky when the experts are called in. For instance, how sure can the parties be that the expert has been diligent in the search for a ‘market rental’ benchmark derived from similar premises and under similar lease terms in prevailing market conditions?”

The parties and their appointed expert/s are responsible for ensuring that the full lease terms under review form the specification for the review. It is the expert’s job to properly research, interrogate and analyse recently negotiated leases on similar terms and for similar premises (showing similar quality, size and location attributes). Where these are scarce, then substantiated adjustments should be made from the source data and aligned to the premises under review.

Portside tenants need to be wary of review clauses which refer to the determination of an ‘open market rental and escalation’ in, paradoxically, a ‘closed’ market environment such as a Port precinct where there is a single landlord with 100% control over the supply of property.  In such cases, specific review criteria need to be agreed upon which are fair and equitable to both parties.

Landlords also need to be wary of drafting ‘User’ clauses into leases which confine tenants to a specific activity. On review, the expert will be required to confine his research in a similar way.

“An interesting example of this occurred in Camps Bay’s Victoria Road, arguably the most expense retail strip in the country - where restaurant shell rentals are at R400/m2 rising to R550/m2, a certain oil company’s forecourt rental (the tenant) was up for review recently. The forecourt was located under the upper restaurant level slab. The ‘user’ clause in the lease confined the tenant to the sale of fuel, oils and products associated with a petrol forecourt, together with a 24 hour shop.  The forecourt rental was determined, correctly, as a proportion of forecourt sales at around a R35/m2 equivalent when expressed across the lease area. The landlord submitted that the market rental value, with retail rights, was around R350/m2, net of conversion costs. The arbiter and senior council, ruled in favour of the tenant,” explains Fitchet.

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