The PROPERTY DOCTORS, Sydney Australia Novak Properties

EP. 1416 THE BIGGEST MISTAKE WHEN NEGOTIATING A COMMERCIAL LEASE!

• Mark Novak, Michael Burgio • Season 30 • Episode 1416

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Negotiating commercial leases is a high-stakes game where seemingly small details can snowball into massive financial consequences. This episode peels back the curtain on the critical elements that make or break lease agreements for both landlords and tenants.

We start by tackling the fundamental question of who pays for lease preparation - revealing how retail and commercial standards differ and how the typical $2,000 cost is increasingly being split 50/50 between parties. But this is just scratching the surface. The real financial landmines lie hidden in the fine print that many skip over.

For landlords, we expose how extended option periods with pre-programmed low rent increases can trap you in financially unsustainable arrangements for years. Even more surprising? These option periods that significantly limit your flexibility don't even enhance your property's value with lenders. We share startling examples of landlords who've signed away their financial futures with poorly structured 12+ year leases, and explain why COVID-era concessions should have been strictly time-limited.

Tenants face their own set of pitfalls. We break down how experienced landlords leverage the magic of compounding through seemingly small rent increase percentages, and why property condition clauses that nobody reads can result in shocking $50,000+ bills when it's time to vacate. The notorious "make good" clause alone has bankrupted businesses who failed to understand their obligations.

Perhaps most problematic is the deceptively simple term "outgoings" - a chameleon-like word that can encompass vastly different cost obligations depending on how it's defined. Is it just council rates and strata fees, or does it include land tax, agent fees, building insurance and maintenance? Without specificity, this single term can lead to bitter disputes and unexpected expenses.

Whether you're a seasoned property investor or signing your first commercial lease, this episode delivers practical wisdom to protect your interests. Have questions about your specific lease situation? We're offering free advice even if you're not in our service area - just reach out and mention this episode!

Speaker 1:

negotiating leases like a ninja the do's, the don'ts, the tips we're going to give you this morning. Stay tuned, I'm the ringleader, so I'm gonna. Oh, are you ready for this one? Who pays for the lease? I always hear that everyone's like dumbfounded by the question.

Speaker 2:

The tenant, the landlord, the agent, yeah, so for a retail lease, by law it is the landlord. However, if the tenant sends like a million changes and a lot of them are unreasonable, then those variation charges can be paid by the tenant. With a commercial lease, ie a warehouse and office space, historically it was 100% the tenant, but these days, with a little bit more sort of say, tenant power, buying power from the tenant side, it's becoming a lot more negotiated point. But previously it was just default tenant and a lot of deals were seeing 50-50 in the lease preparation cost, which a typical lease preparation cost is about two thousand dollars geez, that was a quick one.

Speaker 1:

Let's imagine if we can, if we can blast for the rest of them like that. Okay, let's do it so um that's everything there that's everything there.

Speaker 1:

Um, biggest mistake that you've seen, burge, when you when you open up a lease. So you're a bit of a doctor. When you open up a lease and you look at it and you go ooh, ooh, ah, what are the pinch points that you're looking at when you're looking at a lease? We are talking at the moment commercial. We can switch over to residential after, but tell me about commercial.

Speaker 2:

Don't have to All right, don't have to all right. Um, I think the biggest, the biggest thing to start from. So, uh, do we want to go either?

Speaker 1:

tenant errors first, or landlord errors? Okay, let's go. Let's say you uh, landlords throwing you a lease and said check this out, see if it's all right. What do you think? What do you look at when you release?

Speaker 2:

the biggest thing I'm looking at. It seems quite simple, but the start date and the end date so I can determine where the option period is. And because a lot of the time a landlord will do that, let's say they've done a five-year lease and they're sort of five years into it, or four and a bit, they go, the tenant's first term's running out. What's my position? They throw you the lease. So a big point is finding out where they actually are situated in the lease, and a lot of owners don't know or they miss the dates. Another, yeah, because with an option period you've got to know if the rental negotiation will be at market rent or is it a fixed increase like mark just the difference there can be quite dramatic, especially over a five-year lease term.

Speaker 1:

The market's changed a lot or can change a lot yeah, wow, so that's all pre-negotiated up when you're initially signed. So when you're a tenant or a landlord, you know that if you, if you take up yes, I'd like to stay the option that may be a pre-defined number or that may be a. You know what's happening in the market. Let's look at the market. Let's do do that number.

Speaker 2:

Market value, yuck yeah and another big thing I get the lease and it's like for 20 years or it's got five options in the lease. It's a two plus two. I saw one the other day. It was like a one plus one plus one plus one up to 10 years and I was like, wow, that's not the best for the owner. That's a bit of a mistake there.

Speaker 1:

And with those rent increases.

Speaker 1:

some people can string themselves up hard. Um, whether it's a landlord like we've got I've got clients that have signed a lease like I think it's three, three plus three plus three plus three plus three, the option lays with the tenant, not with the landlord. So the landlord's committed to 12 years. The tenants got three years if they want, they've got six if they want, they got nine or 12 if they want. Where the kicker was was that the rent was so low and I was just like, oh my God, you are getting such cheap rent here and that was pre programmed in the list for the increases and I was like the land has just been screwed. What agent would allow a landlord to sign a lease like this?

Speaker 2:

And just two parts there. Another reason why a lot of those options aren't favourable for the owner is the banks don't value them either. So a bank I remember chatting with valuers I'm like, oh, but there's an option for X amount and we don't even look at that. It's just a fixed term, so there's no advantage for that owner. They're giving up their. The tenants, as you said, got all the control for 12 years and there's no benefit to the owner. It's not like that he can turn around and say, oh, the bank love it, that security, it's false and just what you're saying.

Speaker 2:

With the lower rent, like don't get me wrong, during COVID there were some cheap rental deals done. But the biggest thing I said to the owner was if we're going to do a cheap deal, we can only do a one or two year lease. They give. Let's get the tenant in there, let's um have them do their fit out, they start their business, but then we can look at a market increase very, very quickly. But I know the lease you're talking about. It was like five years at nearly a half price rent.

Speaker 1:

So with these leases, this is really interesting what you said about finance Owners have got to be really careful. It didn't seem like funding related a lot tied back to leases as hard that it does now. So you better make sure, mr Landlord, that you're doing a decent lease, a good lease, a wholesome lease, because your funder is going to, is going to charge you a higher interest rate or not even give you funding if you've got a lease yeah.

Speaker 2:

Now another thing. A mistake is outgoing. It's not clearly being stated. I was going through a lease for a client the other day and we were just looking at land tax and the terminology was wrong. They called it proportion of building expenses. Now that word doesn't really exist. It's either outgoings or utilities. A lot of people confuse water and's either outgoings or utilities. A lot of people confuse fire, water and electricity with outgoings. But no, they're the utilities. Outgoings are your land tax, council and strata and a lot of time in that lease it's not clearly defined. So what happens is and I've seen on many properties you know you get an offer accepted, you know, yeah, all outgoings pay, paid, including land tax, and then we get to the lease and it just says outgoings being paid, um, say, 100 agents fees.

Speaker 1:

That's an outgoing that's exactly right.

Speaker 2:

It just says 100 of outgoings. But where is that line? Because some people when you say it's just outgoings, it's understood. It's just council water and strata, and then sometimes it's council water, strata, land tax, and then sometimes it's council water, strata, land tax. Building insurance agent fees.

Speaker 1:

So what is property maintenance and outgoing?

Speaker 2:

It can be definitely yeah.

Speaker 1:

Anything can be definitely yeah, anything, yeah, yeah, yeah, what a war zone if it's listed and it's not good enough to just say 100 of outgoings, because everybody has different standards.

Speaker 2:

Um, and someone from the outside must hear this and be like how is that? Like, how can that get screwed up? You're the paying all the outgoings or you're not?

Speaker 1:

how do you miss that? How do you miss that yeah?

Speaker 2:

is the thing. So a lot of owners don't make it clear in the lease and it may, it doesn't may not bite you year one, but in five years' time, especially if that tenant sells their business and the new tenant goes through that lease with a fine-tooth comb and says it doesn't say I pay this. Where does it say I pay this? And you can miss out.

Speaker 1:

That's a good, yeah, because when you're compounding these mistakes or compounding these benefits, or whatever you want to call them, depending on whose favorites in this can, this can add up to 50 grand, 100 grand, they like. They can be big numbers. So these leases, if you've got a muppet of an agent that puts a lease together, which can happen, um it because you're trying to save money at the beginning, um, big mistakes. So I like being one removed as a landlord and having a solicitor check that lease and do that lease, because I think the solicitor gives their two bob's worth as well as the agent. So you may have selected an agent that hasn't negotiated the lease properly, but the solicitor often will turn around and go ah, this is a bit well, it's not right, it's a bit shit. Or vice versa, you may have an agent that's guiding the deal to be a stronger lease and telling the solicitor to make it a stronger lease in terms of its terms and the way it's being worded.

Speaker 2:

Now what about the tenant? What are some big mistakes a tenant makes when they're negotiating a lease?

Speaker 1:

Look, first-time tenants I find are weaker in their negotiations probably not anymore with ChatGPT, but they're weaker with their negotiations and the creeper is the outgoings and the creeper is the rent increases is the outgoings and the creeper is the rent increases. So if a landlord can get a tenant to sign on a five percent increase per annum fixed and an option period, it's a fixed increase of five percent again.

Speaker 2:

that can add up to a lot of money after seven years, eight years, ten years no, you're exactly right and I think sometimes tenants just need to slow down and do the numbers where you're exactly right and sometimes an owner will go okay, instead of five hundred dollars a week, I'll take you 450. But I want five percent annual increases instead of three. And at the beginning, at at the point of signing, signing the tenants, they've gotten the best deal. But, as you said, yeah, after five or ten years in that premise, premise and that rent's going up, they're like, wow, these increases really add up.

Speaker 1:

So and you see the experienced landlords. They're really good at that yes, they.

Speaker 2:

they play the long game very, very well and a lot of tenants need to do that. Another mistake tenants make is the condition of the property when accepting it and then leaving. What are their expectations? What are they meant to do? Because a lot of the time a tenant will get they get the property in not the best condition and then they think they can leave it in that condition. But what they forget is they got rent free. The point of the rent free to do the work has now taken that they got that property with brand new carpet, brand new painting and that's how they've got to get it back. So a lot of the times they don't understand like they ask for the rent free and then they don't know what that includes and a lot of the time it's deep and make good clause.

Speaker 2:

Yeah and make good clause. It's massive. It's nothing that's never considered with a tenant, but it's a big cost. We just got a deep cost on a property fifty thousand dollars. Now imagine having your bond. You want to get that back or you're closing because your business isn't doing well, getting hit with a fifty thousand dollar bill just to rip everything you put in out or even just to bring it back to the condition the landlord expects. But you weren't aware it had to be brought that back and it was an unsurprising call. So that can definitely be um a mistake a tenant makes well, they are the mistakes when negotiating commercial lease.

Speaker 1:

There's some basic ones, but always feel free to ring us, even if you're not from the area out of the the area, not a Novak customer always feel free to ring us and ask us Go. Hey, I saw this episode and I'm worried about this. Or can you help me with that? We're always happy to help you, guys. I just had a client last night that I met when I was at dinner and he reminded me. I said that to him and he took me up on it. A long time ago. We've done a lot of business since, always a long time ago.

Speaker 2:

We've done a lot of business, since always feel free to you know he was buying something on central coast.

Speaker 1:

So always feel free. Feel free to ring us up and ask us, even if it's not in the dollar for us. Yeah, thank you very much everyone. Thank you, mr bergio. See you later.