Market rent reviews in commercial and retail leases - matters to consider

Most commercial and retail leases provide a mechanism to review rent by ‘market review’. In most leases, a market review is conducted either at the commencement of an option term or during long term leases (e.g. every five years).

Market rent reviews are a crucial component of commercial and retail leases to ensure rent remains reflective of current market conditions.

The following is a high level overview of the key matters which should be considered when determining market rent.

The drafting of the lease is paramount

The key consideration when undertaking a market review, is the particular drafting of the lease. In most matters, determining the rights and obligations of parties when determining market rent simply turns on the drafting of the lease.

Commonly, leases containing a market review mechanism provide that within an agreed period before the relevant review date, the landlord may give notice to the tenant as to what it considers to be the market rent payable on and from that review date. If the tenant does not dispute the landlord’s assessment, the rent determined by the landlord will be payable from the review date. If the tenant disputes the amount, the parties can either attempt to come to a mutual agreement or, failing that, appoint a valuer to determine the rent.

The terms of the lease must clearly set out the rights and obligations of the parties when determining rent, including timeframes and the matters that must, and must not, be taken into account when determining the rent. For example, the lease may be silent as to the what matters the landlord must take into account when making an assessment of the market rent; however, the lease might then set out the matters a valuer must take into account if the tenant disputes the landlord’s assessment.

The case of Legal and General Life of Australia Limited v A Hudson Pty Limited, provided that ‘the question is not whether there is an error in the discretionary judgment of the valuer. It is whether the valuation complies with the terms of the contract’ (emphasis added).

Subsequent case law provides that by entering into a contract (i.e. a lease), parties agree to be bound by the terms of that contract and, provided the valuation complies with the contract, the parties are bound by it. The NSW Supreme Court has also previously overturned a valuer’s determination of rent on the basis that the valuer had not determined the rent as required by the terms of the lease.

Retail leases

Where a commercial lease falls within the scope of the Retail Leases Act 1994 (NSW) (RL Act), the lease must also comply with the provisions of the RL Act.

The RL Act automatically inserts certain provisions into leases and acts to override any provisions of leases which are inconsistent with the RL Act. In some circumstances, penalties may also be imposed for breaches of the RL Act.

The purpose of the RL Act is predominantly to protect the interests of the tenant. In particular, ss 31-32B of the RL Act expressly provide a mechanism of market reviews.

Section 31 of the RL Act inserts into every retail lease containing a market review, certain requirements when determining market rent, including that a valuer must take into account the following when determining market rent (contained in s 31(1)(a) of the RL Act):

• the provisions of the lease
• the rent that would reasonably be expected if the premises were unoccupied and offered for lease for a substantially similar use
• the gross rent payable under the lease (less the landlord’s outgoings payable by the tenant), and
• any rent concessions and other benefits that are frequently or generally offered to prospective tenants of unoccupied premises,

but a valuer must not take into account the goodwill created by the tenant’s occupation of the premises or the value of the tenant’s fixtures and fittings in the premises.

The provisions of the RL Act are not exhaustive and retail leases may contain additional provisions dealing with the determination of market renew, provided those provisions are not inconsistent with the RL Act.

The NSW Supreme Court considered a dispute between a landlord and tenant of a retail lease in Hanave Pty Ltd v Nomad Sydney Pty Ltd in the context of the RL Act and held that, among other issues, those matters described in s 31(1)(a) of the RL Act must be considered by a valuer when determining market and the valuer’s determination will not be binding if those matters have not been adequately considered.

Sparke Helmore frequently assists a broad range of clients with the preparation, review and advice of commercial and retail leases. If you have any queries or require legal assistance with your commercial and/or retail leasing matters, please don’t hesitate to contact us.