Recent Developments Impacting Tenants and Occupiers

We are currently experiencing dynamic times in commercial real estate. This short summary details some of the current market trends, commercial practices and legal developments that are impacting on tenants and occupiers of industrial and commercial property.

"Effective" market rent reviews

There are changing levels of lease incentives being offered in various real estate markets across Australia. Incentives typically take the form of delayed commencement dates, substantial rent-free periods and landlord's fit out contributions. There have been recent cases of incentives reaching 40% plus in some markets with reports some parts of the sublease market for office space reaching 60%. The growing gap between "effective rents" (i.e. rent adjusted to take into account prevailing incentives) and "face rents" (i.e. the actual rent payable on the face of the lease) is resulting in challenges in determining current market rents at the time of market rent reviews. Critically, for tenants, the treatment of incentives need to be carefully considered in lease negotiations. This is to ensure the market rent review provisions, as drafted into leases, properly reflect a true market position and do not result in out-of-market rents on exercise of lease renewals.

Lease incentives

The availability of incentives, by way of landlord's contribution to tenant's fit out, are susceptible to landlord default. This is due to looming cash flow and funding issues facing some landlords, particularly as the size of incentives are growing. Successors, such as mortgagees in possession, in some instances are refusing to be bound by incentive arrangements claiming that any covenant to pay such amounts are not binding on them because they have not been fully disclosed or consented to. Although a landlord contribution to fit out is often an attractive form of incentive from a tenant's point of view, the right for a tenant to switch any unpaid portion into a rent-free period offers some protection from potential default by landlords in meeting their incentive commitments.

Capital maintenance

The emergence of distressed landlords, landlord insolvency issues and mortgagees taking possession of leased property has resulted in many tenants finding it difficult to procure landlords and, in some cases, receivers and managers or mortgagees in control of the premises to carry out required repairs and replacements and ongoing maintenance to their premises. This is impacting on the quality and amenity of leased premises and possible Occupational Health and Safety issues. In such a market, tenants should consider negotiating into their leases specific rent abatement rights in the event of services failure or a failure of landlord to carry out maintenance and repairs. An alternative in some cases is for a tenant to have the rights to carry out such works and set off the cost against rent payable.

A right of abatement or set-off is particularly necessary given the recent case of Cakirgoz & Crouch [2008] NSW SC1124, in which the Supreme Court reaffirmed the position that a tenant is not entitled to abate rent for breach of a landlord's obligation to carry out repairs unless there is a specific provision in the lease for rent abatement.

"Make good" negotiations

Landlords with cash flow issues are generally more inclined to accept cash payments in lieu of actual "make good" of their premises. This is often in the hope of securing a double benefit by then leasing the premises to a new tenant with the outgoing tenant's fit out offered as an incentive. For prospective tenants, careful drafting of these clauses help avoid a "poison pill" on the lease expiry, failing which a strategy needs to be put in place by tenants on expiry of their leases to minimise their "make good" exposure.

Energy reporting

Under the Natural Greenhouse and Energy Reporting Act 2007 (NSW), building owners or occupiers may have to report on their energy use if such use exceeds certain thresholds. The first reporting is due in October 2009 and occupiers of large portfolios need to carefully initiate a program and consider their reporting obligations, including whether their leases require mechanisms for landlord disclosure of energy consumption relevant to their premises and, if not, how this information may be sourced.

Green lease issues

Despite the delay in the commencement of the proposed Emissions Trading Scheme, the ongoing development of Green Star and NABERS regimes, reporting obligations and an appetite for sustainable development is seeing the ever increasing use of green lease covenants, many times of a generic nature. The impact of these clauses on the use and occupation of premises is often not fully understood by tenants. Green lease provisions need to be carefully considered to ensure that they are appropriate, having regard to the relevant premises and proposed use, and flexible enough to deal with emerging technologies and future legislative developments.