1. New Lease to a New Tenant

The strongest indicator of market rent is a newly negotiated lease with a new tenant. These transactions reflect genuine market forces—willing landlords and tenants negotiating without the influence of existing lease terms or goodwill considerations.

2. Market Rent Agreed

Where landlords and tenants agree to market rent (without a determination process), this also provides useful evidence. However, care must be taken to ensure the agreement was made at arm’s length and not influenced by broader commercial arrangements.

3. Market Rent by Determination

If parties cannot agree, market rent may be set by an independent determining valuer. While this carries weight, it is one step removed from the open market, as the determination process is influenced by expert opinion rather than a negotiated transaction.

4. Renewal of an Existing Lease

The weakest form of evidence comes from lease renewals. These can be affected by premiums paid to protect goodwill or fit-out, or by the tenant’s desire to remain in place for business continuity. Such factors may inflate or suppress rent, making renewals less reliable as evidence of true market rent.

Why This Matters

Understanding this hierarchy helps landlords, tenants, and valuers focus on the most reliable data points when reviewing rent. It reduces disputes and ensures rental outcomes that reflect the actual state of the market rather than isolated or biased circumstances.

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Effective Rent is the Benchmark

Where incentives are not mentioned in the lease, courts have clarified that the review must be conducted on an effective rent basis. In Levy v Victoria Towers Pty Ltd [2003] QCA 204, the Queensland Court of Appeal confirmed that ignoring incentives produces an artificial outcome inconsistent with what a willing but not anxious landlord and tenant would agree in an open market.

Supporting Authorities

Several other decisions reinforce this principle:

– CML Assurance v Tasal Services (1992) — Incentives cannot be excluded from consideration; a market rent determination that ignores them is invalid.
– Edmund Barton Chambers v MLC (1986) — The court confirmed that all relevant market evidence is admissible, not just rent-review outcomes, meaning incentive-affected deals are part of the evidence base.
– Re ANZ Executors & Trustees Co Ltd (1991) — Incentive payments were held to be relevant; their effect depends on how the valuer adjusts comparables.

Practical Application for Valuers

When the lease is silent on incentives, the valuer should:

1. Identify comparable evidence — including transactions with incentives.
2. Normalise to effective rent — adjust comparables so face rent plus or minus incentives is expressed as an equivalent annual rent over the term.
3. Document the adjustments — explain clearly how rent-free periods or fit-out contributions were treated.
4. Respect protective clauses — if the lease includes a “no decrease” provision, ensure the determination is not set below passing rent, even after adjustment.

Why It Matters

The consistent message from the courts is that market rent reviews must reflect the true economic value of comparable deals, not simply headline rents. For landlords and tenants alike, this ensures outcomes are aligned with the reality of market conditions rather than distorted by the absence of drafting clarity.

Key takeaway: If a lease is silent on incentives, the review is effective — incentive-affected transactions are admissible, adjustments are required, and the valuer’s role is to transparently reconcile face rent with real market value.

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1. Specialist Retail Valuer’s Guide: State-specific Regulations

The applicability of the Retail Lease Act depends on the State where your shop is located. There are certain restrictions on the eligibility of the application of the Retail Leases Act in each State. Some of these are discussed below.

New South Wales (NSW):

1. Applies to all leases of ‘retail premises’ entered on or after 1 May 2003.
2. Covers retail shop leases entered or renewed before or after 28 October 1994.
3. Applies to leases entered or renewed after 1 July 2002, or variations made after that date, relating to retail shop leases entered into after 1 July 2004.
4. Does not apply to leases for a term of fewer than 6 months or greater than 25 years ( including options), leases for premises over 1000m² and certain uses are excluded from the Act https://legislation.nsw.gov.au/view/pdf/asmade/sl-2022-813.

Queensland (QLD):

1. Applies to retail premises leases with a lettable area not exceeding 1000m² entered on or after 28 October 1994.

Victoria (VIC):

1. Applies to leases with a lettable area not exceeding 1000m² entered into before 1 September 1998 if varied after that date.
2. Applies to leases where the rent exceeds the prescribed threshold of $1m per annum in rent or a Lessee that is listed entity, regardless of when the lease was entered into or renewed.

South Australia (SA):

1. Applies to retail premises leases entered after 30 June 1995.
2. Does not apply to leases for the carrying on of a service station business if the Competition and Consumer (Industry Codes – Oilcode) Regulation 2006 (Cth) applies.
3. Applies to leases where the rent exceeds the prescribed threshold of $400,000 per annum in rent or a Lessee that is listed entity, regardless of when the lease was entered into or renewed.

Western Australia (WA):

1. Applies to leases of retail premises entered into on or after 1 January 2013.
2. Does not apply to leases for a term of fewer than 6 months or leases entered by certain entities like ADIs, insurance companies, local councils, or the Crown.
3. Applies to leases with a lettable area not exceeding 1000m² but a Lessee that is listed entity, regardless of when the lease was entered into or renewed is excluded.

Tasmania (TAS),

1. Applies to leases of retail premises entered on or after 1 September 2018.
2. Does not apply to leases for a term of fewer than 6 months or leases entered by certain entities.
3. Applies to leases with a lettable area not exceeding 1000m² but a Lessee that is listed entity, regardless of when the lease was entered into or renewed is excluded.

Northern Territory (NT):

1. Applies to leases of retail premises entered on or after 1July 2004.
2. Does not apply to leases for a term of fewer than 6 months or leases entered by certain entities.
3. Applies to leases with a lettable area not exceeding 1000m² but a Lessee that is listed entity, regardless of when the lease was entered into or renewed is excluded.

Australian Capital Territory (ACT),

1. Applies to leases of retail premises entered on or after 1July 2002.
2. Does not apply to leases for a term of fewer than 6 months or leases entered by certain entities.
3. Applies to leases with a lettable area not exceeding 1000m² but a Lessee that is listed entity, regardless of when the lease was entered into or renewed is excluded.

These regulations outline the conditions under which the Retail Lease Act applies in each State, ensuring that small retailers receive protections under their lease agreements. It’s essential for retailers and lessors to understand these state-specific regulations to determine their rights and obligations under the law, as they override certain provisions in leases where they are in conflict.

2. Specialist Retail Valuer’s Guide: Protection for Small Retailers in relation to Market Rent Reviews

One of the main protections relates to market rent reviews for option leases and midterm market reviews. A summary of these is below:

1. Rents can fall below the current rent i.e. the market rent can fall;
2. Incentives are required to be taken into account;
3. The permitted use of the premises is to be taken into account;
4. Grossed up rents including outgoings are to be used for market rental comparison;
5. The lessee’s fitout and goodwill are to be excluded.

Understanding these protections is essential for retailers and landlords, as they negotiate lease agreements and navigate the complexities of the commercial real estate market, particularly in relation to market rent reviews.

Specialised rental valuations of retail, childcare, medical and aged care are complex and multi-faceted.  IPS Consultants is an independent consultancy and Specialist Retail Valuer in Sydney with more than 25 years of experience in this field and regularly provides complex analysis in these areas. Contact us today.

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As with any property, the size and layout of the retail strata shop are crucial to its valuation. However, strata shops may have different layouts compared to non-strata shops as they require access through common areas to shared amenities and storerooms. A strata shop with non-exclusive use of shared amenities is less valuable than one with exclusive use, even if they are located outside of the shop’s premises. This applies to loading docks and the use of garbage and compactor rooms as well.

One of the first issues to address is car parking and storage areas. In most cases, these areas are included in the strata area and do not require a separate license. However, if these areas are not part of the strata area and are licensed separately, they will need to be valued separately as well.

Another important issue to consider is the number of shops in the building. If there are less than five shops in the building and the prescribed use does not fall under the Retail Leases Act, these shops may not be considered as retail use and may not receive the protections of the Retail Leases Act. This can greatly impact the property’s value, as the protections provided by the Retail Leases Act can greatly benefit the tenant.

The strata area shown may also be different from the Gross Lettable Area Retail, which will again impact the value of the shop. For example, areas under 1.5 meters in height are excluded from GLAR. This will also impact the comparability of other non-strata shops, which are measured by GLAR.

Recoverable outgoings in shops are typically lower than in non-strata shops, all other things being equal. Therefore, when comparing gross rents, this needs to be factored into the valuation considerations. Furthermore, the recovery of sinking funds in strata schemes is regulated under the Retail Leases Act of NSW.

Strata shop by-laws can also impact the value as they may restrict the usage of certain areas such as loading docks, use of goods lifts, rubbish rooms, etc. Furthermore, there may be undocumented restrictions on the use of the retail shop due to the provision of shared services. For example, extractor fan ventilation may disturb above-level residents, and the strata manager and Council could impose restrictions on the night time trade of a ground-floor food tenancy.

In summary, additional consideration of strata retail shops is crucial to get their valuations right. This includes factors such as the measurement of areas, outgoings, strata scheme by-laws, and other restrictions on usage.

Specialised rental valuations of retail, childcare, medical and aged care are complex and multi-faceted.  IPS Consultants is an independent consultancy with more than 25 years of experience in this field and regularly provides complex analysis in these areas.

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The use of occupancy cost ratios in the valuation of market rents for commercial and retail properties has been a topic of debate among real estate valuation professionals for many years. These ratios, which compare the rent and outgoings of a property to the gross sales of a particular tenant, are often used as a benchmark in the leasing process, particularly in shopping centres. However, their use in determining market rents remains controversial, particularly in retail standalone or strip locations. One of the main arguments against the use of occupancy cost ratios in rental valuations, is that they consider the goodwill and fitout of the tenant.

Valuers are tasked with determining the market rent of a property assuming vacant possession, which means ignoring any value associated with the tenant’s existing business, goodwill, and fitout. However, most market rent reviews are triggered by options, where a sitting tenant wishes to extend their lease and will have an established business and fitout. On the other hand, both landlords and tenants often use occupancy cost ratios in the leasing process to determine the affordability of a property for a particular use. This shows that these benchmarks are considered by the market and cannot be completely ignored in the valuation process. In shopping centres, the use of occupancy cost ratios to set rents for new leases and renewals is routine, as this information is readily available.

Another issue with occupancy cost ratios is that they do not consider the location and market conditions of a property. A high occupancy cost ratio may be acceptable in a prime location with high foot traffic and strong demand, but the same ratio in a less desirable location may be considered too high. This highlights the importance of considering other factors in addition to occupancy cost ratios when determining market rents.

Despite these criticisms, occupancy cost ratios can still be a useful tool in the valuation and leasing process. They provide a benchmark for both landlords and tenants to assess the affordability of a property for a particular use and can be a starting point for negotiations. In the past, obtaining this information was a challenge as there were limited sources of business benchmarking available. However, with the rise of big data, the Australian Taxation Office (ATO)  now provides a comprehensive range of small business benchmarks, including rent expenses/turnover benchmarks. The ATO has access to millions of business records, which they use to ensure tax compliance. This means that the ratios provided in their benchmarks are reliable and can be used as a guide for landlords and property owners. However, it is important to note that these benchmarks are usually 1-2 years out of date, so they should be used as a general reference rather than an exact measure.

Furthermore, they should not be the primary determinant of market rents and should be used in conjunction with other valuation methods and market data. In conclusion, the use of occupancy cost ratios in the valuation of market rents for commercial properties remains a contentious issue. While they can provide a useful benchmark, they should not be relied upon as the sole method of determining market rents. Valuers must consider other factors such as location, market conditions, and the individual characteristics of each premises to arrive at a market rent.

Conclusions

Specialised rental valuations of retail, childcare, medical and aged care are complex and muti faceted.  IPS Consultants are an independent consultancy with more than 25 years’ experience in this field and regularly provide complex analysis in these areas.

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Valuation in the realm of commercial real estate involves a complex interplay of factors that influence the worth of a property. When it comes to Specialized Use Rentals and Precinct Rentals, the valuation process takes on a unique dimension. In this blog, we’ll delve into the intricate world of valuation considerations for these rental types, using the example of a specialist medical use, such as a Veterinary Hospital, to shed light on the dynamics of rent economics and location influence.

The Case of Specialist Medical Use: Veterinary Hospitals

Consider a specialist medical use like a Veterinary Hospital. These establishments require highly specific facilities, equipment, and amenities to operate effectively. In a recent analysis of Veterinary Hospitals across Sydney, it was observed that despite varying locations, these businesses lease within a narrow range of rents. This phenomenon hints at the strong influence of the specialized use on rent economics, potentially overshadowing the impact of location.

Valuation Considerations for Specialized Use Rentals:

1. Specialized Infrastructure: The presence of specialized infrastructure and equipment heavily influences the valuation of a property. Properties equipped to accommodate unique needs tend to have a higher intrinsic value for businesses with those specific requirements.

2. Replacement Cost: Valuing specialized facilities involves considering the cost of replicating the infrastructure from scratch. This could entail significant investment, impacting the property’s overall value.

3. Demand-Supply Dynamics: The scarcity of properties tailored for specialized uses can drive demand, potentially influencing rental rates and property value.

Valuation Considerations for Precinct Rentals:

1. Location and Foot Traffic: The valuation of precinct rentals often centers around location. Properties situated in bustling commercial areas with high foot traffic and accessibility tend to command higher values.

2. Amenities and Shared Services: Shared amenities and services within a precinct contribute to property value. Access to facilities like parking, conference rooms, and security can enhance the attractiveness of a location.

3. Diversity of Businesses: The variety of businesses within a precinct can impact valuation. A vibrant mix of industries can create a dynamic ecosystem, potentially increasing demand and property value.

Interplay Between Specialized Use and Precinct Rentals:

The intriguing aspect arises when we observe how specialized use rents and precinct rents interact. While precinct rents often align with the value attributed to the location, specialized use rents may show a discount or premium. In the case of the Veterinary Hospitals analysis, the narrow range of rents despite varying locations suggests that the economics of the specialized use significantly dictate the rent quantum.

Potential Factors Influencing Specialized Use Rent Premiums/Discounts:

1. Market Demand: If the market demand for a specific specialized use is high, this could lead to a rent premium, as businesses are willing to pay more to secure a property tailored to their unique requirements.

2. Scarcity: If specialized properties are limited in supply, they might command higher rents due to increased demand from businesses that need those specific facilities.

3. Operational Efficiency: Specialized facilities can enhance operational efficiency, potentially justifying a premium due to the cost savings and productivity gains they offer.

Conclusion:

Valuation considerations in the context of Specialized Use Rentals and Precinct Rentals are multifaceted and intertwined. The example of Veterinary Hospitals highlights how the economics of a specialized use can hold more weight than location in determining rent quantum. The interplay between specialized use rents and precinct rents showcases the complex relationship between business requirements, property amenities, and market dynamics. For businesses seeking to lease specialised space or have market rent reviews and renewals, understanding these valuation nuances is crucial for making informed decisions that align with their financial and operational objectives.

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The NDIS and SDA: Transforming Lives

Enacted in 2013, the NDIS stands as a groundbreaking initiative, providing a lifeline for over half a million Australians with disabilities. Funding is allocated to individuals, empowering them to make choices regarding their service providers and support systems. Among these services, SDA plays a vital role, aiming to create living spaces that enhance independence, comfort, and overall well-being.

The Growth and Scope of SDA

The NDIS’s reach has been impressive, with over 518,000 people benefiting from its services as of April 2022. SDA, being a crucial component of this scheme, addresses the specific housing needs of individuals with disabilities. Over 30,000 NDIS participants are expected to be eligible for SDA funding, and an annual budget of $700 million is allocated to develop these specialized accommodations. Remarkably, only half of this budget is currently utilized, underscoring the potential for expansion and development in this sector.

Diverse SDA Building Types and Designs

SDA properties come in various types, reflecting the diverse requirements of individuals with disabilities. Apartments, duplexes, villas, townhouses, houses, and group homes are designed to cater to different preferences and levels of independence. Moreover, within these building types, there are six design categories, ensuring that the properties are tailored to meet the specific needs of the occupants.

Investment Analysis: Pros and Cons

For investors, SDA properties represent a unique and potentially lucrative market. The advantages of investing in SDA housing include above-average rental income and high returns on investment, typically ranging from 10% to 15%. Moreover, SDA funding is guaranteed until 2036, offering a level of security for property owners. Rental yields are also linked to inflation, providing a hedge against economic fluctuations.

However, challenges exist. Vacancy issues might arise in oversupplied locations, delays in obtaining sufficient SDA funds, and policy changes can impact investment success. The niche nature of this market and the complexity of its regulations may also make selling these properties challenging.

Landlords and Participants: A Complex Relationship

In the realm of SDA accommodation, relationships between landlords, SDA providers, and NDIS participants are structured through intricate agreements. The Accommodation Agreement, typically ranging from 2-5 years, governs these arrangements. Additionally, SDA providers often enter agreements with Supported Independent Living providers, managing the accommodation and support services. The cashflow profile of landlords is closely linked to the SDA provider’s ability to secure participants and manage support services.

Looking Forward: SDA as an Emerging Investment Class

SDA Accommodation is an evolving market with increasing investor interest, including institutional players. Although not yet a mainstream investment class, it holds promise as an investment-grade asset over the medium term. As the market matures and gains recognition, yields and cap rates are expected to compress, driving up the value of SDA properties.

In Conclusion

Specialist Disability Accommodation within the NDIS is a testament to Australia’s commitment to creating an inclusive society. By addressing the unique housing needs of individuals with disabilities, SDA properties contribute to improved quality of life and independence. The valuation of these properties requires a multifaceted approach, considering factors such as location, design, and ongoing support. As the SDA market continues to evolve, it holds promise as a niche investment class that benefits both investors and the individuals it serves.

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BCom, Dip Val, MMGT AAPI 

Managing Director 

IPS Consultants 

An option is the right granted under a lease whereby the Lessor grants to the Lessee the right (but not the obligation) to enter into a further lease term of the premises after the expiry of the initial lease, within a specified timeframe limited in the initial lease. 

In Australia, the responsibility for exercising an option correctly always falls on the Lessee, as the lessee receives the benefit of a new lease.  In other countries it is at the Lessor’s discretion. 

However, exercising an option correctly is not straight forward and requires detailed knowledge of your own lease, relevant Retail Leases Act in the applicable States, relevant case law and Real Property Law.  It also requires you to be diligent with regard to managing dates and keeping up with your obligations under the lease. 

Remember that leases are complicated financial instruments and expert legal advice should always be sought. Also, if you think you are alone in your dilemma in managing options, take heart – Some of the biggest names in corporate real estate have missed options as well! 

Case Study – The Lock Out 

The businessman stares at the silver chain strung around the entrance to his once thriving business. He glances up at glass entrance doors which have newspapers and magazines stuck to them that masked ten years of ‘blood, sweat and tears’ plus more than half a million in fitout costs. Disbelievingly he says” I never thought it would get to this.”

This was one extreme case of an option exercise that went horribly wrong. This involved a restaurant with a lease term of ten years plus a ten year option. The restaurants proprietor had a well established and well known business on a prominent corner location, on a busy retail strip.

The owner of the restaurant knew he had an option and with approximately two months left until the expiry of his lease, he shot off an email to his landlord which went like this:

Dear Mr Landlord

Please be advised that I wish to exercise my option, subject to you replacing the kitchen exhaust and for the rent to remain the same as discussed.

Best Regards

Mr Tenant

Approximately one month later, the restaurateur receives a letter via registered mail from the Landlord’s solicitor, which said words to the effect of:

Dear Mr Tenant

We act for Mr Landlord. Your lease at 21 Desolation Row will expire on 31 March 2007. Accordingly the owner will require vacant possession of the premises by close of business on that date.

In accordance with Clause 9 of your lease you are required to make good the premises on or before expiry date. Should you wish to discuss this matter, please contact the undersigned.

A Solicitor

Immediately, the restaurateur picked up the phone to his solicitor and shouts

“Look there has been a mistake here at my restaurant. I just got a letter from the Landlord’s solicitor threatening me with eviction. I exercised my option, I will forward you the email I sent to the Landlord and fax you this letter. Can you immediately sort this out, as this is critical?

The next day the restaurateur receives a call from his solicitor.

“Look, you have a problem. You didn’t exercise your option in time and furthermore it wasn’t done in the correct manner. Unfortunately your option has lapsed. I spoke to the Landlord’s solicitor and he has re-iterated the Landlord’s intention to take possession of the premises at your lease expiry.”

“But I wasn’t aware there was a time limit on when an option can be exercised. Look we can’t just let him take away my business like that. I have always had quite a good relationship with the owner. Let’s offer him an increase on the rent and I will pay the arrears on the place. Lets set-up a meeting for next Monday with the owner and we will finalise this option.”

The result of this case was the tenant lost his right to the option and the lessor took possession of the premises. The tenant lost his business and he also lost his security deposit, as he didn’t make good the premises in accordance with his lease.

In this case, the lessee made several fundamental errors, which will be reviewed at the end of the chapter.

We will start with the basics by examining what an option is, when do they occur, what are the implications for exercising an option or not and review of the methods and techniques to correctly exercise an option under a retail lease. Lastly we will reexamine the Lockout Case to see what should have occurred.

So what is an option under a lease?

An option is the right granted under a lease whereby the Lessor grants to the Lessee the right (but not the obligation) to enter into a further lease terms of the premises after the expiry of the initial lease, within a specified timeframe limited in the initial lease.1

In Australia, the responsibility for exercising an option correctly always falls on the Lessee, as the lessee receives the benefit of a new lease. In other countries, it can be at the Lessor’s discretion.

However, exercising an option correctly is not straight forward and requires detailed knowledge of your own lease, relevant Retail Leases Act in the applicable States, relevant case law and Real Property Law. It also requires you to be diligent about managing dates and keeping up with your obligations under the lease.

Remember that leases are complicated financial instruments and expert legal advice should always be sought. Also, if you think you are alone in your dilemma in managing options, take heart – Some of the biggest names in corporate real estate have missed options as well!

In the following sections, we will explain the key elements for exercising an option correctly.

The Option Exercise Window 

Example 1

A lease over a shop in NSW commenced on 1 July 2005 for a term of five years with an option for a further five years. The lease contained a provision that stated the option must be exercised no earlier than six months prior to the expiry of the lease and no later than three months prior to the expiry of the lease.

The Option Exercise Window 

There are three critical dates here. The expiry date of the lease, the option exercise start date which is the earliest date which the option can be exercised and the option exercise end date, which is the last day an option can be exercised. The Start and End date of the Option Exercise period is known as the Option Exercise Window. If the option is exercised outside the window, either too early or too late, the option will generally lapse.

The option exercise window will vary from lease to lease and therefore each lease must be read thoroughly and the critical dates diarised.

What if you miss your option exercise window? 

Generally if a lessee misses their option exercise window, then the option will lapse, unless the lessor agrees to formally extend the option exercise window. There maybe some exceptional circumstances where a lessee maybe able to plead an ‘accident or surprise’2. If you get into that situation you need to immediately seek qualified legal advice.

Whilst getting the dates right is critical in exercising an option, there are equally important factors which must be carried out.

Part 2 – Exercising An Option and being ‘locked in’ without the lessee intending to be

Another common mistake that lessee’s make relates to exercising an option under the misunderstanding that option terms are ‘conditional’, in particular that the rent can be ‘negotiated’ and if the lessee is not happy with that rent proposed by the Lessor then they can walk away from the option lease. In most cases, retail lease options are not conditional, in other words, if the lessee exercises their option they are bound by the terms of the option lease. This will usually involve a market rent review, which is not a negotiation. Market rent reviews will be dealt with in the next chapter.

Lets examine a case involving an exercise of an option, where the lessee didn’t really intend to exercise their option.

Case Two – Locked In

The Board for some time had been unhappy with the premises that the business had been in. They had instructed their general manager to make it known to the Lessor that they wanted a number of items in the building upgraded or repaired, if the Lessor wanted to keep them as a tenant. The General Manager was also asked to conduct research into alternative premises and make recommendations regarding suitable space and appropriate leasing rates.

The Board and general manager were aware that the option exercise window was about to expire, however they had no intention of staying in the premises, if the Lessor was not prepared to upgrade the premises to suit their business needs.However the Board’s intention was to ensure that the business was able to stay in the premises until such time as a commitment to upgrade the building was forthcoming from the Lessor or suitable alternative accommodation could be secured.

The General Manager had a meeting with the Lessor just prior to the last day of the exercise window, in which the Lessor stated that they would be unable to commit to any upgrade to the premises unless the Lessee exercised their option. It was disputed as to what was actually said between the parties. The General Manager then wrote a letter to the Lessor, exercising their option and signed it off as a General Manager of the company. The Lessor acknowledged receipt of the letter and confirmed that the lessee had exercising their option. The Board was not aware that the Lessee had exercised their option and only became aware at their Board meeting which was not for some time afterwards. Furthermore in this lease, there was a fixed rent review at the expiry of the lease. The lessee paid the increase in the rent.

At the next Board meeting it was revealed that the general manager had written a letter exercising their option. The Board immediately wrote a letter to the Lessor, stating the following:

• The lessee had no intention of exercising their option, due to the condition of the premises, which was made known to the Lessor on numerous occasions;
• The general manager had no authority to bind the company, as he did not have authority to do so
• The option letter was null and void, because it was not executed correctly
• The option notice was conditional on the Lessor agreeing to upgrade the premises and therefore not valid
• The option lease was not signed by the Lessee
• The lessee had made it known to the Lessor that they intended to hold over and the lease was effectively a month to month tenancy.

The lessee gave notice to the lessor after several months into the new lease and left the premises. The Lessor sued the Lessee and the case went to Court,for breach of contract. The court held that the Lessee had in fact excercised their option, even though the Board had not approved it, and the option lease was not signed. In this case as the Lessee was a corporation, the court held that Lessor was entitled to rely on the documentation it was provided.

The Impact of Missing an Option on Market Rent

Option provisions within commercial leases usually contain a market rent review. If an Option is not exercised. then the Lessor and Lessee can still agree on a new rent, however the Lessee will not get the benefit of a market rent review, unless both parties agree.

Market Rent Reviews require a third-party professional Valuer, who is independent to consider the value of the premises on a vacant possession basis, meaning that the value of the Lessee’s Business Goodwill, Fixtures and Fittings are excluded from the market rent. Usually, but not always, the Valuer is to have regard to Incentives such as Rent Free and Contributions to Fit out, which further reduce the Market Rent. Furthermore, in relation to Retail Premises covered under the Retail Leases Act, the Valuer is to have regard to the same or similar uses as the lease.

In order to avoid such issues, it is important to understand the process of market rent reviews and how to correctly exercise options .

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1. Location- The old adage in real estate has never been more important in retail. CBD locations are still undergoing structural changes  due to the Pandemic. Many regional locations are booming on the back of the great sea/tree change post Pandemic. Neighbourhood shopping centres and some retail strips are benefiting from the phenomenon known as the hyper local economy as more people work from home and shop locally.

2. Usage- Retail uses are a major driver of rents. Supermarkets, mens fashion, footwear, electronics, furniture and take away food are still experiencing strong sales growth whilst other uses are moderating or declining.

3. Timing – We expect the first half of 2023 to be more difficult for some retailers  than the second half, all things being equal. Interest rate rises, moderating residential property prices and global uncertainty will dampen consumer confidence and demand. This will help to dampen inflation which is expected to normalise towards the back of 2023 or early 2024.

4. Lease structures- Rental escalations linked to CPI increases vs fixed reviews will  impact the overall rental values of leases over the short to medium term. Incentives are likely to remain high for new lease deals as access to finance and rising borrowing costs limit retailers capacity to fund store expansions.

So every lease deal needs to be carefully analysed using these four key themes. Best of luck to all for 2023!

Simon Fonteyn is an Executive Director of FLNT  -the leading commercial real estate data portal in Australia incorporating Leaseinfo- Australia’s largest provider of retail leasing data. He is also a specialist retail valuer and founder of IPS Consultants www.ipsconsultants.com.au

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What is a BATNA analysis?

BATNA stands for ‘Best Alternative to a Negotiated Agreement’. This tool was developed in 1981 by Roger Fisher and William Ury in the book ‘Getting to Yes: Negotiating Agreement Without Giving In’. The BATNA strategy recommends that before entering and concluding a negotiation, you should assess what the best alternative will be in the case the negotiation fails and/or there is a superior alternative.

This allows you to prepare yourself if the deal does fall through, but also is helpful as it can put into perspective whether perhaps the negotiation is not your best course of action. Importantly, undertaking a BATNA provides a valuable negotiating tool, as it also considers what your interlocutor’s BATNA position is.

BATNAs are critical to negotiation because you cannot make a wise decision unless you know what your alternatives are.

How do you work out your BATNA?

The first step of determining your BATNA is to identify any feasible alternatives to the deal which you will be negotiating. Evaluate potential alternatives and select the option which possesses the highest expected value.

Once you have decided on the highest value option, take this best possible alternative and calculate the projected revenues and costs. You now should have your best alternative price – the lowest value deal you will be willing to accept in your negotiation – and an alternative to offer bargaining power.

How do you use the BATNA analysis?

If the proposed agreement is better than your BATNA, you should accept it. This is the ideal result and the best outcomes occur when the BATNAs of both parties are equal, allowing the parties to reach a mutually beneficial agreement.

If the agreement achieved is not better than your BATNA, you should reopen negotiations until the deal is of higher value than your alternative. If after reopening negotiations, you cannot improve the agreement, then you should at least consider pursuing your next alternative.

Example

As an example, let us assume that your current lease stipulates:

Now what if your landlord proposes a 10% increase on the existing lease with 5% annual rental increases? The Net Present Value of five years of future rent at the current store = $980,044.

Your ‘Best Alternative to the Negotiated Deal’ is to move to a new centre where you will get a:

20% reduction on current rent, contribution to fitout of 10% and new fitout of $90,000. However, your sales will decrease from $ 1,000,000 to $950,000 per annum. The Net Present Value of five years of future rent at this store = $814,009.

As the alternative is better than the current agreement, you should reopen negotiations to try reach the break-even point of a 5% rental reduction. If the agreement cannot reach this break-even point, all else equal, the best alternative will be to relocate to the new centre where you will be better off overall.

Using your BATNA as a negotiating tactic

Your BATNA does not always just have to be hypothetical, it can be a practical tool used to encourage a Landlord to disclose their true position.

You should genuinely search and research your best alternative location.

Start the lease negotiation process early – ideally at least 18 months before lease expiry. Look at tenant rollover rates in the subject centre and make applications at alternative sites.

It is likely that if you are making alternative applications, other managing agents will contact your current centre’s managing agent for a trade reference, at which point your Landlord will know you are serious about alternative options, thus making it more likely your Landlord discloses their true position and can make you an improved and honest offer.

Author

This post was authored by Simon Fonteyn. Simon is one of Australia’s leading experts in retail, childcare and medical leasing and rental valuations. He holds a Degree in Accounting & Finance, a Diploma of Valuation, a Masters of Management and is an Associate of the Australian Property Institute. With over 25 years experience in the commercial property industry, Simon founded IPS Consultants as a way to provide more transparency to the industry.

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