Many tenants and landlords are unaware of the tools to help them negotiate the market value of their lease. In this article, Simon Fonteyn of LeaseInfo discuss the process of rental determination, how to apply for them, how they are conducted and how to ensure that your voice is heard in the process.
For most retail businesses rent is the second largest expense after staffing. Understanding the value of your lease is critical to rent negotiation, occupancy costs, budgeting, and by extension overall business success. Many businesses do not utilise the options at their disposal when in a disagreement about the value of their lease, one of these key options is known as a rental determination.
What is a rental determination?
Simply put, rental determinations occur where there is a market rent review and a tenant and landlord cannot agree on the market rental value of their lease. An expert valuer is then appointed to determine the rent independently. Market rent reviews are a common way for landlords and tenants to bring rent back in line with the market value of the lease.
There are four ways in which the rent can be increased:
- By a fixed percentage or amount
- By the consumer price index (CPI)
- A combination of the above two. E.g. CPI + 2% or the greater or lesser of (1) and (2)
- Market Rent Review
Usually, during a market rent review negotiation, a landlord and tenant will each submit evidence and market research and use this to agree on the market rent. When the parties cannot come to an agreement is when a rental determination occurs.
Market rent reviews will usually occur either in the middle of long leases knows as a Mid Term Market Reviews or when a tenant chooses to exercise an option within their lease known as an Option Market Rent Review. Leases may not contain a market rent review at all; this is common for short leases and leases that do not contain options.
Conditions affecting determination
There are different types of rental determinations depending upon the use of the lease. If the permitted use of the lease falls under the Retail Leases Act (RLA) in each State, then the determination process is governed by the RLA in that State and a Determining Valuer can be appointed jointly by the parties (tenant and landlord), the Small Business Commissioner or by Court order.
For all other types of determinations, the Determining Valuer is either jointly appointed by the parties or the Australian Property Institute will nominate a Determining Valuer.
The main difference between leases that fall under the RLA and others that do not is that the RLA takes precedent over any other instructions that may be written in the lease where they are in conflict.
The most common conflict is ratchet clauses (meaning the rent cannot decrease) can be voided. In layman’s terms, this means that if a lease stipulates that the rent cannot decrease, the RLA will override this clause protecting the tenant’s right to a rent decrease in a falling market.
The Determining Valuer
A rental determination is conducted by a Specialist Retail Valuer who is a valuer who has had at least five years’ experience and has completed a special accreditation through the Australian Property Institute.
A Specialist Retail Valuer will examine an extensive number of factors (see below for full list) including: location, size, shape, utility, frontage, frontage to depth ratios, incentives and may use a retail leasing database to view comparable leases.
Under the RLA the valuer has the right to obtain information pertaining to factors that affect the market particularly in relation to a shopping centre such as incentive data, other rents within the centre and sales history.
Outside the RLA, the valuer can request that information, but the parties are not legally obligated to provide it. However, the valuer can reject the determination, if insufficient information is provided or disclaim the valuation due to incomplete or insufficient information.
Remember the Determining Valuer is following the instructions in your lease, unless in conflict with the Retail Leases Act.
What is the difference between a regular valuation and a rental determination?
The difference is that the determination outcome is usually binding on both parties with the exception of a Retail Leases Act determination where either party has the right to a review which is conducted by a third party(s) of other expert retail valuers.
What can you do to influence the determination process?
Under all determinations, both parties have the right to make a submission to the Determining Valuer which must be taken into consideration. Submissions can be completed by a retained valuer or you can construct your own report.
Here is a list of the minimum number of items you should include in your submission to the Determining Valuer include:
- Locational issues
- Market conditions and how the market influences the value of your lease e.g supply/demand, trading conditions
- Specific lease details and any issues within the lease e.g Demolition clauses
- Comparable evidence (similar leases) obtained from a retail leasing database or the Land Titles Office
- Incentives (Inducements to Lease)
- Historic and current sales and Moving Annual Turnover (if Retail)
- Changes to the business/ industry over time
- Physical aspects of the property including condition, amenities such as parking, access and egress, proximity to transport etc.
Note: The Determining Valuer is not an expert on:
- Legal issues
- Engineering issues
- Surveying issues
- Environmental issues
So any issues such as these, may require the Determining Valuer to obtain expert advice.
In RLA cases, each party covers 50% of the determination cost, however this may vary outside the RLA, depending upon instructions within the lease.
How is it applied?
Once the determination has been completed the rent is back dated to the date of the Market Rent Review by applying either a credit (if there is a decrease) or an adjustment amount (if there is an increase). If the lease comes under the RLA then no rental adjustment can be made until the determination has been completed. Outside the RLA the lease governs how rent is to be charged, pending completion of the determination.