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As a tenant or landlord under a commercial lease, your business will be affected by rent reviews during the life of your lease. Therefore, it is essential that you understand the most common types of rent reviews.
Four commonly used methods to review annual rental for a commercial lease are Consumer Price Index (CPI), Fixed, Turnover, and Market reviews and the process of undertaking these reviews will be outlined in your lease.
CPI review & Fixed review
A Fixed rent review provides for a prearranged rental increase at regular intervals during the term of a lease. The process for this review will typically be calculated by taking the annual rent payable immediately prior to the Fixed review date and multiplying that by the percentage increase on each Fixed review date.
A CPI rent review is determined by an adjustment of the annual rent in accordance with the CPI which is a measure for inflation published by Statistics New Zealand every quarter. This is calculated by taking the current annual rental and multiplying it by the increase in CPI between the rent review dates. While CPI rent reviews are based on publicly accessible information, disputes can still occur where a calculation is not agreed to, or CPI figures are not available.
The rent determined by way of Fixed or CPI review will be payable from the relevant rent review date, and usually the landlord serves notice of the reviewed rent payable under a CPI and Fixed rent review.
The benefit of both Fixed and CPI increases is that they provide certainty to both the tenant and the landlord as they are calculated using a set formula. However, Fixed and CPI reviews are not always an accurate reflection of the actual market value of the rent.
Turnover Review
Under Turnover rent, tenants pay a set base rent for a premises and then are required to pay the landlord a percentage of their annual turnover. Most often, turnover rent is paid in arrears. This could be calculated on the anniversary of the lease, the financial year, or some other date as defined in your lease. This means that financial records must be provided to the landlord so that the turnover rent can be determined for the period outlined in your lease.
Turnover rent helps reflect the value that a tenant is getting from a particular lease. More popular areas should equal higher turnover and the tenant will pay for that privilege. Tenants can also reduce their costs when sales are low (such as during the COVID-19 lockdowns). This shares risk between both the landlord and the tenant. However, Turnover rents can be complex to administer which leaves more room for dispute, and cooperation between the landlord and the tenant is essential for a Turnover rent to work.
Market review
A Market rent review adjusts rent based on the current market at the time of the rent review. A valuer will assess the factors specific to the premises such as location, desirability of the area, and the value for other similar premises. Market reviews often act as a reassessment of the rent for a particular premises to bring it back into line with the current market. It may be that Fixed or CPI increases have raised the level of the rent well above what the actual market is for that type of premises. A Market review can help realign the rent with current market conditions.
Rent reviews in leases can be combinations of Fixed, CPI or Market reviews and may also provide that the rent is to be the higher of a CPI, Fixed, or Market review on a particular review date. It is common for a lease to have a CPI or Fixed review annually with a Market review on a renewal date of the lease and during the midway point of a longer term.
Ratchet clauses
When a CPI or Market review is undertaken it is possible for rent to decrease. Ratchet clauses prevent this and there are two main types:
Soft Ratchet: A soft ratchet allows the rent to decrease but prevents it from decreasing below a certain point. Typically, a soft ratchet clause will state that the rent can never be below the rent at the commencement date of the lease.
Hard Ratchet: A hard ratchet only allows for rent to increase, meaning that the rent can never be below the previous rental payable under the lease.
Hesketh Henry regularly assists both tenants and landlords with leasing matters. If you have any queries about commercial leasing matters or rent reviews, please get in touch with the Property Team or your usual contact at Hesketh Henry.
Disclaimer: The information contained in this article is current at the date of publishing and is of a general nature. It should be used as a guide only and not as a substitute for obtaining legal advice. Specific legal advice should be sought where required.
