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Advantages in finalising the market rent before a tenant exercises an option for a new lease term
In brief – Both landlord and tenant benefit by agreeing on the market rent
Tenants who have an option for a further term contained in their lease can benefit from asking the landlord to confirm the market rent payable for the first year of the option term before exercising the option. This avoids the undesirable situation of a tenant being bound by a lease where it cannot afford to pay the rent.
Retail tenants are entitled under the Retail Leases Act NSW to ask the landlord to have the market rent determined before the tenant exercises its option. Commercial tenants do not have this protection.
Market rent review procedure
A lease which contains an option for a further term generally provides that the rent for the first year of the option term will be determined by a market rent review process.
If the landlord and tenant cannot agree on the market rent, the review process will usually take the decision away from them and place it in the hands of a valuer.
This means neither party can be certain of the result of the rent review and both will generally be bound by the result, even if they do not agree with it.
The valuer’s determination of the market rent can only be challenged if it has not been made in accordance with the lease. It is not possible to challenge the determination on the grounds that the valuer has made an error or has over or under valued the premises.
Retail leases
A tenant of retail premises is entitled under the Retail Leases Act NSW to ask the landlord to have the market rent determined before the tenant exercises its option.
The Act allows the tenant to make this request at any time within the period that begins 6 months before and ends 3 months before the last day on which the option may be exercised (or the period that begins 3 months before and ends 30 days before the last day on which the option may be exercised in the case of a lease with a term of 12 months or less).
If a tenant makes a request of this nature, the period within which the tenant must exercise the option is varied so that the last day on which the option may be exercised is 21 days after the determination of rent is made and notified to the tenant in writing.
Commercial leases
Commercial tenants are not protected by the Retail Leases Act NSW. A commercial tenant could attempt to negotiate some protection into the lease prior to entering into it, for example, by adding a clause which obliges the landlord to provide a notice of market rent prior to the option expiry date. Clauses of this nature are not common.
A commercial tenant is free to ask the landlord before the option expiry date for details of the proposed rent for the first year of the option term, even if the right to do so is not contained in the lease.
If the landlord does not agree to provide an early determination of market rent then the tenant may wish to obtain its own valuation before exercising the option. If the tenant does so, it needs to be aware that this valuation is indicative information only. The landlord is not required to consider this valuation and is not bound by it.
If you have a question in relation to an option clause in a lease or whether an option has been correctly exercised, please contact: