Commercial Rent - What is market rent?
An interesting trend has developed in commercial leases over recent times. Readers would be aware that incentives are frequently offered to potential tenants which induce them into entering into leases. These are a normal part of the process and can take many forms from rent free periods and discounts to fit-out contributions or cash payments.
Face Rent/Effective Rent
In recent times, the industry appears to be omitting such incentives from inclusion in the formal lease documentation. Landlords are, instead, requiring such incentives to be included in separate Incentive Deed (or in a collateral agreement). This creates a two-tiered market rent system. The first tier is based on what is described as “face rent”. As this description implies, this is the rent that appears on the face of the lease. This is publicly available (following registration of the lease) and experts in the commercial leasing area are able to collate information based upon the registration of the relevant material and which will assist them in determining the market rent.
When incentives are excluded from the “face rent” or the lease documentation itself, then assessment of the market is skewed in favour of the landlord. Rents will appear to be higher than they actually are because no adjustment is made for the incentives that are offered to tenants to take possession of the premises.
What is created as a result is an artificially high market rent. This is clearly of advantage to the landlord when negotiating new rents and is also an advantage to the landlord when seeking finance based upon, at least in part, the level of rent that appears to be received from the tenanted properties.
The second market rent is that which includes the incentives. This will necessarily be less than market rent determined on the face of the lease. It is generally referred to as the “effective rent”.
As a tenant you must be aware of the difference and the clauses that dictate how market rent will be determined.
Wording in the Lease
Market rent is also determined by reference to the precise wording used in the lease. Back in 2009, the Victorian Court of Appeal had to deal with a lease that referred to the term “annual current market rental”, but also separately referred to a term “annual current market rental value”.
The landlord and tenant disagreed about market rent and the matter was referred, as is usually the case, to an independent valuer. The landlord suggested the market rent was to be reviewed byreference to “face rent”. The tenant suggested that the review would have to be undertaken by reference to the “effective rent”. In the case in question, the inducements and incentives were quite substantial. At all times, the landlord linked the expression “current annual market rent” with the notion of “face rent”, and the expression “current annual market rent value” with the notion of “effective rent”. The tenant believed the terms to be synonymous.
The valuer agreed with the tenant and valued the property on an effective rent basis.
At first instance, the valuer’s determination was upheld. On appeal, however, it was overturned. The Court of Appeal held that the provisions of the lease required a determination of face rent and found that the two expressions were significantly different in meaning. As a lawyer who reviews many leases it is extremely common for leases to wrongly use different words to describe similar things (current rent, rent, rental, face rent, rental value, existing rent – when describing how much the rent is and market rent, face market rent, market rental, current market rent, current market rent value and new rent when describing new rent to be imposed following a market review). The lesson learned from this case is that a Court will usually find that the use of different words requires them to be given different meanings.
What to do When Negotiating Your Lease
It is essential that you ensure that precise and unambiguous language is used in your lease (and indeed in any agreement you sign). Carelessness in relation to the use of words that appear synonymous can have a material and marked affect on the outcome of any judicial interpretation of your lease or contract.
You must be very aware of the difference between base rent and effective rent and, in negotiating for your lease (and in relation to any market reviews during the lease), you will need to be very clear about what will be taken into account in respect of that valuation.
You should always remember that even where the context of the lease suggest terms should be treated relatively synonymously, the law will actually assume that where different words are chosen, different meanings are intended. Accordingly, you should ensure that the same words are used wherever appropriate.
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