Commercial Leases (Part 3): Key Differences Landlords and Tenants Should Understand

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You're listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

Welcome back to another episode of Explain That by Velocity Legal.

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This is Part 3 of a three-part series covering terms, options and the expiry of leases.

I'm joined by Joel Garrett.

We've been discussing in Part 1 some of the fundamentals, entering a new lease processes, overholding and what to expect at the end of the lease.

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In Part 2, we dived deep into a case study involving the renewal process for a retail lease.

And in Part 3, this part, we'll be discussing some specific elements and issues within the leasing confines of extending leases, options, things like that.

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So welcome back to the show, Joel.

What issues are we going to be talking about in this part?

So I've picked a few.

One of the major little processes for renewal leases is the market rent review process. Things aren't going right and the landlord and tenant can't agree, go off to the VSBC and get them to appoint someone to determine the rent.

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While those determinations are binding on the parties, there is an ability to be able to set those aside.

So we're going to discuss some of the reasons or ways that they can be set aside from previous cases, just clauses to be wary of when you're appointing an independent valuer.

1:24
There's the recent case that would be interesting to discuss in terms of being required to re-engage the valuer that has had the determination set aside, and just things to be aware of when you're negotiating terms in a non-retail lease.

As we raised in the previous episodes, non-retail leases are sort of the Wild West.

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They're not governed by legislation.

So it's really important that those terms have been carefully drafted and the process is governed appropriately, more from a tenant and landlord perspective.

Fantastic.

Well, let's dive into the first issue you mentioned, the ability to set aside VSBC determinations.

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So there's several ways that it can be set aside.

In saying that, I think the threshold is quite high. You need to be able to really demonstrate that the valuer hasn't done their job properly.

Some of the reasons are the inadequacy of the valuer's written responses.

There's different ways that a valuer can go about valuing market rent.

2:21
One of them is the profits method.

So in this case it was called Higgins Nine Group Pty Ltd and Ladro Greville Street Pty Ltd.

In this one, the valuer's reasons were found to be inadequate because the valuer utilised the profits method as an alternative means of determining rent.

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VCAT found, however, that the valuer failed to provide detailed reasons explaining the calculation of the projected higher turnover figures for the new term, and the determination was set aside.

So this valuer has probably gone ahead and made an incorrect assessment or assumptions about the expected profits of the tenant and didn't give appropriate reasons as to why they came to that conclusion.

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So in this case, the tenant was successful in having the determination set aside because it was clearly unfavourable. The determination was too high and the valuer didn't give adequate reasons as to why they used that method and those turnover figures.

Consideration of lease terms can be another way to set aside a determination.

As part of the legislative requirements for a valuer.

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The valuer has to have regard to the lease terms fully, including the length of the term, the length of the term's effect on the current market rate, any options for renewals, and any special conditions in the lease that might affect the rental value.

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So if it's clear that the valuer hasn't really deep dived into a lease and considered all of those things, because all of those things, those commercial key terms, assist in determining what an appropriate rent would be.

If you're having a really, really long lease and a landlord has guaranteed rent for a really long amount of time, that might be a way to negotiate a slightly lower rent because the landlord will be happy to have the place tenanted.

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If it's a short lease, the landlord might demand a premium for not having guaranteed rent for a long time.

So if the valuer is not having regard to those terms and it's not properly detailed in the determination, that can be reason to set aside the market rate determination.

The other one would be an incorrect assessment of outgoings.

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Rent determinations should accurately assess what the landlord's outgoings are and what the liability of the tenant is in contributing to those outgoings.

So there was a case in VCAT where the member set aside a rental determination because the valuer failed to explain why they incorrectly categorised outgoings in terms of maintenance of the landlord's fixtures or the fit-out in the premises.

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Under the Retail Leases Act, a landlord has obligations to maintain and repair its own fixtures and fittings, the structure of the premises, and plant and equipment.

In this particular case, it was Josephine Ung Pty Ltd and Jagjit Associates Pty Ltd.

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The valuer, I think, had a misunderstanding of the landlord's obligations and costs in terms of those legislative requirements and incorrectly apportioned those costs towards the tenant in determining its rent.

So it made an error, like a pretty fundamental error, in misunderstanding the actual outgoings that could be passed on to a tenant.

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So it's something to be aware of and a way to set aside the determination.

Failure to account for incentives is another one. The valuer has to consider rent concessions or other benefits offered to prospective tenants of similar unoccupied premises.

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So if those aren't appropriately considered and reflected as part of this determination, that could be a reason to set aside the determination.

And another one would be failure to have regard to premises being let for the same or similar use.

So one of the most common methods of valuation is to use comparable premises, because if you're using comparable premises in a similar area, that's probably the most accurate reflection of what a true market rent would be because these are independent different people who are agreeing on what is appropriate rent.

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So if a valuer isn't having regard to, if they're doing a cafe and they haven't looked at cafes nearby to determine what their rent would be and they just come to a random figure, that would be a pretty clear avenue to set aside its determination as well.

6:44
Yeah, that seems to be one of the most blatant ones, I guess, not considering other rentals.

Just a side question. How do valuers get that information to determine what other rentals are?

Because I'm thinking about sales of residential property, for example. They all get, they ultimately get reported, but does the same happen with leases?

7:06
No, and that's the difficulty in Victoria because our leases aren't required to be registered on the certificate of title.

In, for example, New South Wales, leases need to be registered as a legislative requirement.

That's a good question. I think there's actually a platform or some software that you can subscribe to, and that has details of property details in leases as well. But I've never actually asked a valuer how they find all that information.

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But I'm pretty sure there's a paid subscription to a server. I think that's how banks and bank valuers use that same thing to determine values of businesses or premises as well when they're getting loans. So I think valuers use the same stuff.

I mean, it sounds like there are some grounds.

7:50
So if you're in this situation all the way to the end and you're still not.

There's been a bit in the last few years. There has been a bit more of a trend of being able to set aside these determinations.

I think once there were a couple that kind of opened the floodgates of finding ways to poke holes in a valuation, which brings us to the second point.

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Because if a valuation is set aside, more often than not, VCAT will require that the parties engage another valuer or get another valuation done to fix the mistake of the previous one.

And because of the upwards trend of these determinations being set aside or being able to be set aside, there's been a change to some valuers' terms of engagement.

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And they'll often include a clause now that requires both the landlord and tenant to re-engage them in the event that their determination has been set aside for whatever reason.

That's interesting.

So they've gotten it wrong the first time and they get a second go.

8:52
Yeah, which shouldn't, that shouldn't be okay. But yeah, there's been a trend of that being put into their terms.

And surprisingly, these terms have been held as enforceable in VCAT.

So it's very, very important to review those terms of engagement.

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You don't want to be bound to a valuer who's obviously made a mistake. They're not cheap.

Firstly, they're usually between anywhere between $2,000 and $8,000, depending on what your requirements are.

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Yeah, I would be surprised if the terms of re-engagement said they would do it for cheaper as well.

It's just an opportunity for them to get the job again.

The backstory to that decision to agree that that's enforceable.

So there was a recent case, I think a recent 2021 case, where a determination was set aside for various reasons.

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I think the valuer had consideration to rent being paid by ALDI in a shopping centre, and that would be determining rent for pharmacies.

So there was a bit of a disconnect as to why they had relied on information from ALDI.

This particular terms of engagement had a clause in it that specifically spoke to any reviews of its determination, and if it was set aside, that the parties had to re-engage them.

10:12
The determination got set aside. The parties were required to get a new determination.

One of the parties wanted to reuse the same valuer and they sought to rely on a clause in that valuer's terms of engagement. They said that they must re-engage them in the event that it's set aside.

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The other party sought to oppose that. So they went back to VCAT.

They got VCAT to look at the clause and determine if it was enforceable or not, and whether it had to require the parties to go back to their valuer again.

And VCAT did hold that term to be enforceable and allowed the redetermination to be remitted back to the original valuer.

I don't know who that benefits except for the valuer. Most likely, if the person who's going back to them probably got a better outcome from the set-aside one.

10:59
That's just a strange thing to be aware of.

I don't think the parties would really want to have to go back to the same person who they've just spent time and money going to VCAT to have it set aside, just to have that same person have another crack at it. It doesn't really make sense.

11:14
Yes, I agree.

And then the third issue you had down for this part was about, we talked a lot about retail leases, but those negotiations for non-retail leases.

Yeah. So the process for market rent review is pretty clear cut in the Retail Leases Act.

11:32
But that circumstance needs to be managed quite carefully in a non-retail lease as well upfront.

Generally, the VSBC under a Retail Leases Act will appoint just any kind of qualified valuer.

In a non-retail lease.

11:49
If it's a specific kind of industry, a landlord might prefer that a certain type of valuer with expertise in a certain field must be appointed.

For example, I worked on a lease where it was a non-retail lease and they wanted to make sure the valuer had experience specifically with hotels and restaurants.

12:07
Like it needs to be someone suitably qualified in their eyes who is going to really look at this a certain way.

So it's kind of restricting who can be appointed.

So that can be, which is not something that you do in a retail lease because it's just a specialist retail valuer without any further requirements or experience.

12:28
There's also specific considerations that the valuer needs to think about.

When it's a retail lease, it's pretty limited. They have to have regard to the provisions of the lease, the rent that would reasonably be expected to be paid if the premises was unoccupied and offered for lease for the same or substantially similar use to what the current premises is, or current lease is.

It has to have regard to the landlord's outgoings to the extent that the tenant is liable to contribute to those.

12:56
But it has to have regard to rent concessions or other benefits offered to prospective tenants of similar unoccupied retail premises.

But a valuer can't have regard to goodwill of the tenant.

All of those things can be changed in a non-retail lease.

So landlord, for example, a requirement of one that I've done recently was a non-retail lease, was instead of having regard to a similar use of the premises, as required under the Retail Leases Act, there can be a requirement that the valuer has to consider the highest and best use.

13:30
So it doesn't have to be the same permitted use of the current tenant.

But if they look at the place and think it can be used for this, then it would be this much, that's how much.

The way that the non-retail lease provisions can be drafted can wildly change how a valuer approaches the determination and can be much more favourable to a landlord.

13:48
What about things like incentives?

Because I know in a lot of, not particularly non-retail leases, you have this concept of a face rent and then incentives that are given.

I guess it probably depends on the contract, right? Whether the incentives have to be taken into account, what would be offered to somebody else if this was leased out?

14:10
So for a retail lease, the valuer has to have regard to that.

If it's a non-retail lease, for example, this one that I was talking about, that was specifically carved out.

So the valuer was directed to not have any regard to any incentives or other rent abatements or concessions when going about its valuation and coming to a determination.

14:34
That's quite critical, because some of those incentives could be, you know, 40%, right?

Yeah. That's significant because especially, as we mentioned in the first episode, the vacancy rates are quite high.

So incentives are very apparent at the moment, and for a valuer to be restricted from considering those.

14:56
It's a huge, huge difference.

So it's not something that probably a lot of tenants are thinking about when they're entering the lease, worrying about what could happen in five years' time when we're doing a market review.

But if you're loving that premises and you want to stay on, you need to think about what's going to happen to your rent at that point.

15:16
If these requirements for the valuer are drastically different to what would be commercially reasonable, particularly having regard to what's required under the legislation if it was a Retail Leases Act, you just need to be aware of what's going on and make sure that those terms are fair.

15:32
Yeah. And probably another point is that if you're a tenant in that situation and the option is quite restrictive or unfavourable, then of course, you can walk away and find somewhere else that does have that incentive.

15:47
And there is some risk for, I guess, a landlord if they were to be too onerous, perhaps.

Yeah, well, again, it goes back to the landlord's intentions.

If they want to try and rely on this to push the rent as high as possible, they might do that because they want to develop it, or they want to use it as a way to get the space free and get the tenant out.

16:11
If they're proposing a much higher rent, that might actually be market because they're not taking into account incentives that would generally be offered for a new tenant.

Well, excellent.

Well, we've talked in this part about three issues. One was setting aside VSBC determinations.

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The second was about clauses requiring a valuer who's got it wrong to be re-engaged.

And the third is about negotiating terms in non-retail leases.

And of course, I'm sure there's many more issues. And if anyone does have any questions, assistance with leases, whether from a tenant or a landlord's perspective, recommend reaching out to Joel for some expert assistance.

16:52
So you've given me a lot of insight and knowledge during this series, and I want to say thank you once again for being part of it.

I look forward to our next episode.

Looking forward to it. Thanks, Andrew.

Thanks, Joel.