LEASE EXPIRY

What is the problem?

‘Should I Stay or Should I Go’ the early 1980s hit by the Clash no doubt rings in many ears when there is an impending lease expiry – a decision needs to be made whether a business should stay in its current premises or relocate. This decision can cause great angst especially when mixed with other issues such as:

  • Will I have enough space in the future?
  • Is there something better out there than what I have now?
  • How does my current rent compare with others?
  • Do I need to refresh my fitout or start brand new?

There are so many issues to think about that it is best to narrow it down one at a time.
This piece considers whether you should commit to staying in your current premises or search the market for something better?

The general ‘rule of thumb’

As a general rule of thumb for any lease expiry you should do two things:

1. Always ‘test the market’ ie. find out what is else is available and at what cost to compare it with your current premises.

2. Ask your current landlord for a lease proposal to stay.

Why test the market?

Why should you always test the market? Because:

  • Even if you want to stay in the current premises you will never know whether your current lease deal is competitive ie. ‘good or bad’ when compared with others.
  • There are likely to be good options in the market that are within your budget.

How do incentives affect the decision?

Incentives are a contribution paid by the landlord to the tenant. The incentive can be taken as a fitout contribution, rent abatement or cash (or a mixture). Your current landlord may offer you an incentive to stay but this is likely to be less than what you will be offered by a new landlord enticing you to the relocate to their property.

However, just remember an incentive is not ‘free money’. The landlord recovers this cost over the term of the lease plus interest. It is worth noting that a higher rent with a bigger incentive may be better than a lower rent with a smaller incentive. For example, you may need a large contribution for a high quality fitout which will result in a higher rent – the higher rent being within your budget.

If you want a low rent then you can ask the landlord to take out the incentive. This offer is known as an ‘effective rent’. An effective rent is the ‘face rent’ minus the lease incentive.

What if you have an option to stay?

Your current lease may have an option to extend the lease for a number of years on the same terms and conditions. If this is the case you should ask the current landlord to provide an offer to exercise the option eg. what will be the starting rent at the commencement of the option? This offer can then be compared to your other options to relocate.

Commonly, a lease option triggers a ‘market rent review’ to determine the starting rent. However you need to be careful because commonly these clauses:

  • Do not allow the rent to decrease (known as a ratchet clause);
  • Do not require the landlord to provide you with a new lease incentive.

Often it is best to get some advice on the interpretation of the market rent review clause so you are being offered what you are entitled to under the lease.

What if you like the fitout?

A significant factor of determining whether to say or go is the condition, age and quality of the fitout – there is less interest to remain at your current premises if the fitout has ‘seen better days’. Also note that, generally, a fitout is depreciated over 7 years so it may be worth remaining for a few years more to take advantage of the impact to the profit and loss statement.

Ultimately the decision will come down to the following:

  • Whether the company has capital to pay for a fitout?
  • How much fitout contribution can be obtained from the current or new landlord?

In addition, it is now common for landlords to offer already fitted out spaces so all you need to do is set up the ICT. This is worth looking at, especially if you are only need a small amount of space.

Putting it together

As a starting point for an impending lease expiry you should always:

  • Test the market to determine what other options are available that suit your business and budget.
  • Get an offer from the current landlord to stay and if there is a lease option, an offer to extend the lease.
  • Make sure your offer includes a lease incentive from both the current landlord and the other potential landlords. Though, be aware that this can affect how much rent you pay. If you don’t want an incentive ask for an ‘effective rent’ offer.
  • If the current fitout is working well for the business and the offer is good from the current landlord then it may be worth staying. If you do not like your fitout you may be able to get a brand new one in another location using a fitout contribution. Better yet, a new landlord may have already done a fitout for you – just waiting for your business to move in!

Unfortunately there are no hard and fast rules to determining whether to stay or go – it is a balancing act between your business’s needs and wants. However before making a decision it is highly recommended that you ‘test the market’ as well as getting an offer from your current landlord.