Commercial Condition Reports. Valuable or a waste of time?

Unlike residential condition reports which have been in use for many years and are needed if a dispute arises with a tenant, there is no requirement in the Victorian commercial leasing market. There is no standard report format, no reference to a report in any of the current commercial leases and no mention in any tenancy legislation. The standard form R.E.I.V. authority lists a condition report as a service requirement in the residential authority but not in the commercial one.

What happens at the end of a commercial lease if there is no condition report? That would depend on the terms of the lease. In the R.E.I.V. 2016 lease this is dealt with in clause 10 and the L.I.V. 2014 lease in clause 5. Both require the tenant to remove its fixtures and fittings and make good any damage. The R.E.I.V. lease requires the property to be returned to the condition as at the initial commencement date whereas the L.I.V. lease emphasises a clean condition. If the parties do not agree on the state of the premises then further action may be initiated in court or at V.C.A.T. All the more reason to have some sort of record.

What type of condition report should be used? That would depend on the type of property. A small shop would generally be satisfied with external and internal photos, a list of the owner fixtures and fittings and any general items that are a feature of the property such as fitout, air conditioning or those found in item 1.4 of a standard disclosure statement. Videos can be useful if the premises are substantial and there are companies that can prepare detailed condition reports on HVAC, electrical distribution, data cabling and the like if the intention is to have a corporate office for example returned to its original condition at lease end or if the tenant intends to make substantial alterations.

When would you not want to prepare a condition report? Often this is not needed if the premises were leased as a bare shell and is to be returned as such or the premises are in poor condition and agreement is made for the tenant to renovate. Be sure to amend the lease so that the tenant is not obliged to return the premises to its original condition if the landlord wants to retain the improvements made by the tenant. Often when a building is slated for demolition, there is no need to prepare a report however, as often occurs, the premises do not end up being demolished, are re-let and the tenant and landlord are in dispute over how the property was left. If a report is made, it can always be discarded if demolition proceeds.

When is a condition report useful other than at the end of a lease? Unlike residential properties, commercial properties are often modified by tenants such as new or amended fitouts, particularly food related. A condition report and subsequent recording of the changes after the tenant has moved in and refitted will assist tracking alterations to the premises. This could evolve over many years with the same or new tenants following the sale of a business.

In the residential context, a tenant acknowledges the state of the premises and a report is agreed to by both parties. It is up to the individual owner if they want to seek agreement from the tenant or merely keep a copy for their own records for commercial premises. I have had tenants ask for a condition report at the commencement of a lease but it is rare. Property owners also rarely ask for this unless a problem arises.

A thorough condition report can catch out changes that have been made without consent or where the tenant asserts on vacating the premises that the premises were taken in poor condition and that their changes actually constitute an improvement. That may or may not be the case. Undocumented changes without permits may actually be illegal and require expensive restoration. Landlord’s fixtures and fittings such as floor coverings are often contentious. Were they in good condition at commencement  and can the landlord prove it? Was there pre-existing damage or is it fair wear and tear? Without good photographic evidence the proof required may not exist, leading to dispute.

Condition reports may eventually find their way into standard leases or legislation but in the meantime a report with basic photos and a description of the state of the premises and fixtures and fittings should be on every agents file.

Would You Let A Tenant Insure Your Building?

No is the obvious answer, but it is worth looking at the obligations of both parties under the R.E.I.V. and Law Institute Leases and what they mean in practice.

With the R.E.I.V. 2016 Lease, the owner is allowed to recover insurances premiums under clause 2 (h) of the lease which is fairly encompassing. The landlord can pretty much insure whatever they like at whatever sum they see fit. The landlord is prevented from recovering insurance charges if the Retail Leases Act 2003 applies generally if it is not disclosed in a disclosure statement, covers part of a premises not used by a tenant, the calculation is not on a percentage of floor area and the like. The landlord also has an obligation to provide insurance details to a tenant under clause 21 if requested to do so. There is no requirement on the landlord to actually insure the building so after production of documents, the landlord could merely cancel the policy. This is unchanged from the 2003 version of the lease.

The tenant also has obligations to insure under clause 4 covering public risk, additional premiums by way of the tenant’s occupancy, claims excess payment and tenants fixtures and fittings. Whilst there is an obligation on a tenant to replace glass in clause 5.5 (f) interestingly, there is no obligation on the tenant to insure glass. The tenant is also not required to insure in the joint name with the landlord or note the landlord as an interested party.

With the Law Institute of Victoria 2014 Lease, the owner can recover insurance premiums under clause 1.1(d) and the type of cover is strictly defined and not as broad as the R.E.IV. lease. Public risk premiums are for $10 million as a default so ensure that schedule item 12 is for example $20 million. The same applies to Loss of Rent cover listed in schedule item 13. If you require a loss of rent period of say 18 – 24 months you need to make the appropriate insertion in the schedule as the lease has a default period of 12 months only. The owner has a further obligation to ensure that the  premises are insured under clause 6.2 during the term of the lease unlike the R.E.I.V. lease. The tenant also has obligations under clause 2.1.6 to pay any premium increase due to the basis of occupancy and to insure for public risk for an amount listed in the schedule (the same basis as the landlord noted above) but for not less than $10 million in clause 2.3. The landlord in this case must   be noted on the tenant’s policy. There is no requirement for the tenant to insure their fixtures fittings or stock. Clause 3.2.3 requires the tenant to replace any broken glass but there is no requirement for the tenant to insure glass. The tenant is also required to pay any claims excess under 1.1(d).

Some of the tenancy problems which are encountered with insurance (a topic in itself) include:

1. Under or over insurance. With under insurance the insurer applies averaging to the claim so the landlord will be well out of pocket. With over insurance, the tenant will pay excessive premiums. The lease has no mechanism to rectify either of the above situations although a retail lease may lead to a mediation to resolve the matter. Generally, if the tenant receives an invoice from the landlord which it considers to be excessive, quotes are sought from competing brokers and compared upon which the parties negotiate a settlement. Advice should be sought as policies can be a premium type or bare bones form of cover only and not always like for like. The sums insured are normally arrived at by a valuation if in dispute. You cannot take an educated guess when assessing the quantum of cover.
2. Glass cover is often a basis of dispute wherein the tenant who is paying the landlord’s insurance premium has an expectation that if the glass in the shopfront is damaged, that the landlord has glass cover. Landlords should always have cover to avoid this problem.
3. The noting of a landlord on the tenants policy is also problematic. Will the insurer actually cover the landlord in the event of a claim? The landlord is a third party, has not completed a proposal with the underwriter and may not be an insurable risk let alone that they have seen or read a copy of the policy noting the exclusions of cover.
4. Landlords who also demand copies of tenants insurances as a basis to sleep well at night are unrealistic. The landlord cannot contact the tenant’s insurer to see if a policy is up to date during the period of cover due to privacy legislation and there is nothing to stop the tenant cancelling the policy the day after production to the landlord.
5. Some landlords allow the tenant to take out the cover thinking they are doing the tenant a favour or if it is a large corporation, that the premium will be vastly cheaper. In the event of a substantial or total loss if proper cover is not in place the landlord may be bankrupted or face an appearance in the coroner’s court in several years time. Why would you risk that?
6. Something to consider, If you have just leased to a new tenant in a property that was hard to lease, the tenant is under resourced, a first timer, an extensive fit out is involved or the rent is high, consider loss of rent cover (not loss of income in the event of say a fire) for 12 or 18 months if the tenant gets in financial difficulty. If the tenant survives the first year or so of a new lease their chances of success are much higher and you may not renew the cover. Either way, If you have a large mortgage or are really going to rely on the income then without insurance you may put yourself in jeopardy. The premium is most likely recoverable anyway.

The golden rule is that each party must maintain and control their own insurance cover.

Transfer or Assignment of Lease: What can and should happen, and what to be aware of.

A transfer or assignment of lease normally occurs when the tenant seeks to sell their business or they wish to close or relocate their business and seek another tenant to take over the lease.
The tenant must seek approval in writing from the landlord to transfer the lease and generally the landlord cannot unreasonably withhold consent. The 2016 R.E.I.V. lease deals with lease transfers in clause 14 and in the L.I.V. Lease 2014 edition it is dealt with in section 4.

Each lease has particular clauses and conditions which must be checked when the request to transfer the lease is received. In the case of retail leases, section 60-62 of the Retail Leases Act 2003 deals with circumstances where the landlord can withhold consent as follows:

60. When the Landlord can withhold consent to an assignment -

(1) A landlord is only entitled to withhold consent to the assignment of a retail premises lease if one or more of the following applies -

(a) the proposed assignee proposes to use the retail premises in a way that is not permitted under the lease;
In the case of sub clause (a) the landlord is generally protected from a type of use which the landlord may object to such as a rival tenancy or unpalatable use.

(b) the landlord considers that the proposed assignee does not have sufficient financial resources or business experience to meet the obligations under the lease;
With sub clause (b) it is not unusual that the incoming tenant is inexperienced or does not have substantial cash reserves or significant assets. In cases such as this it is important to request a statement of assets and liabilities on the company and directors or the individual(s) if a company is not the proposed assignee. If the company or individual(s) own the property it is advisable to request a copy of a council rate notice (or conduct a title search) to ensure the owner is correctly listed. If other parties are listed on the rate notice who are not the proposed assignee, such as a spouse, in the event of default, the property can be transferred stamp duty free effectively out of reach or creditors.

References are also required, particularly rental references. This is a primary method of establishing if the tenant pays on time or has been difficult to deal with. Personal and trade references generally carry less weight. In order to assess the tenants' background it is not unusual to request a history of the tenant's experience. Have they owned and run businesses or managed them? Or, perhaps they have little industry experience.

Previously it was a requirement to provide a business plan, however it is not required under the Retail Leases Act 2003 now. Some tenants, however, will provide one as a bona fide display of their intentions.

In some instances the agent may request a credit report on the proposed assignee company and bankruptcy and other checks on the directors. Privacy consent needs to be obtained before a credit agency will process an application on individuals. ASIC also publish the names of people who are banned from being a company director and this can also be checked on the ASIC website.

If the items noted in (b) are positive then the transfer may be approved. If however they are not sufficient then there are some difficult decisions to be made. The landlord can refuse the transfer. The landlord can seek an increase on the security deposit or the provision of additional guarantors. It is unusual to vary the terms by consent such as the level of rent or outgoings. It is not unusual for assignees to seek additional lease options to preserve the value of goodwill and allow for the amortization of any refit costs.

(c) the proposed assignor has not complied with reasonable assignment provisions of the lease.
In the case of sub clause (c), for the assignor not to comply with reasonable assignment provisions this may extend to not providing a disclosure statement to the assignee, not providing adequate documentation to evidence the transfer, there may be an un-remedied default or condition not complied with such as an incomplete fit out and lack of permits.

(d) the assignment is in connection with a lease of retail premises that will continue to be used for the carrying on of an ongoing business and the proposed assignor has not provided the proposed assignee with business records for the previous 3 years or such shorter period as the proposed assignor has carried on business at the retail premises.
Finally, with sub clause (d) it can be difficult to establish that the assignor has provided business records to the assignees so it is important to seek confirmation from the proposed assignee in writing.
Section 61 of the Act outlines the information to be provided by a tenant to the proposed assignee and the landlord. Be aware of sub clause (5) wherein the landlord must provide an updated disclosure statement if requested to do so within 14 days of a request to do so or penalties apply. Sub clause (6)(b) also requires the landlord to accept or withhold consent within 28 days or receiving a request to assign. If the landlord fails to act within this time frame it may be that the transfer is deemed to have occurred.

Section 62 of the Retail Leases Act 2003 has the effect of releasing the tenant and guarantors as at the date of transfer provided a compliant disclosure statement has been issued. It is therefore important to have replacement guarantors in place or an increase in security bond. This release does generally not apply to a non retail lease and the lease should be checked to ensure that. It is also worth noting that a change of the permitted use for a retail tenant does not automatically release the assignor or guarantors. Protection for assignors and guarantors was intended only when a sale of the business occurred.

For a transfer to occur a transfer deed has to be prepared. This is usually prepared by the solicitor for the proposed assignee and is often in the L.I.V. format and is reviewed by the landlord's lawyers.

The landlord is able to recover reasonable costs in relation to expenses occurred by the managing agent and the landlords' solicitor in relation to the transfer. Occasionally, mortgage consent is required and the landlord must provide it although cannot recoup any costs under section 51 (1)(b) of the Act.

The vetting process does require suitable skill and experience to ensure that the landlord is overall in no worse position than before and that as much is known about the proposed assignee as possible.

The consequence of not managing the process correctly are arrears and vacancy or an unenforceable lease agreement. If not handled skilfully, the matter may also end up at mediation or VCAT so the correct advice must be sought from your property manager or solicitor.

Bank Guarantees - a quick guide.

A bank guarantee is a bankers undertaking to unconditionally pay the beneficiary the sum stated on the guarantee. This is similar to a bank cheque and is held by the landlord often for the duration of the tenancy. If you are about to replace a guarantee or have just leased a property and the lease demands that one be provided, what do you look for?

1. Read the lease. With Victorian leases in common use, clause 16 of the 2016 R.E.I.V. Lease outlines the requirements of the guarantee. 16.2 (a) provides that a guarantee must have no expiry date and 16.11 provides that it must be provided before handover. The L.I.V. 2014 Lease deals with guarantees in clause 13.
2. Make sure that the parties are correctly named along with their address and Australian Company Number. If possible try to avoid the landlord being a trust or ownership structure that may require substantial documentation to prove entitlement if the time comes to visit the bank and draw down on the guarantee.
3. Make sure that the sum payable is correct and if possible quote a gst inclusive figure in Australian dollars.
4. There should preferably be no expiry date. If a date has to be inserted, then aim for a date which is at least 3 months after the date following the expiry of the initial term and options combined.
5. Presentation of the guarantee cannot be conditional such as consent from the lessee or other hurdle being firstly required.
6. If the bank listed on the guarantee is not a local trading bank then you should check for a listing with the office of the Australian Prudential Regulator to establish that the bank holds an Australian banking licence. Thank you to Geoff Kliger from KCL Law for this suggestion.
7. If possible, try to obtain a guarantee with a stamp or signature in a colour other than with black ink as the original can easily be confused with a copy and can be very difficult to verify years later.

If in doubt, always read the respective clauses in both leases and any special conditions contained therein. If a guarantee is not provided before handover then insist on a cash bond to be exchanged upon production of an acceptable guarantee or simply do not hand over keys to the premises.

Remember that a bank guarantee generally has the added bonus of not being an asset of the lessee. In the event of the appointment of a tenant administrator, receiver or liquidator, a cash bond may have to be returned for distribution to creditors whereas a bank guarantee is beyond their reach.

Commercial Property Leasing ABCs

If you have not reviewed all of your vacant listings, you should act without delay or you will be looking over your shoulder. The start of a new year demands that all of the things you said you would do differently this year are now put into practice. Leasing can result in some of the best and lowest fees payable but all listings should be approached with the same enthusiasm. The best operators I have seen have done over 75 lettings in a year. Average ones 35 or less.

Your biggest draw card used to be the largest sign board you could fit on the building but now it’s the Elite Plus internet listing. Meeting anyone on site who rang up used to get results but time spent sitting in Melbourne traffic is time wasted and prospects need to be better qualified as you are working against the clock at all times. You also need to know as much about the property as you can upfront. Demand answers from the PM or landlord. If you are still asking questions after more than a month you will appear either as either lazy or a goose. Don’t be that guy.

1.   Photos.
Professional is best. Don’t have one photo of the shop with the old tenant's signage on there. Take lots of photos or better still, a video. Ensure it is clutter free and as bright as possible. Capture any views, historic features and high quality neighbours if they are there.

2.   Condition of the premises.
If work is needed, consult the landlord and PM. Damage should be repaired not left to the imagination of a new tenant to see beyond. The property should also be clean including windows and lawns mowed. Whilst the building is vacant it is the best time to attend to any general maintenance. Do stair rails, bollards or windows need painting? Exit lights that work and up to date fire equipment mean that the owner cares about the property. A run down building says to a tenant that nothing will change once they move in. Old signage should be painted out as well. Arrange for the power to be connected. You can’t inspect a property if it is in the dark!

3.   Advertising.
Signs are still good publicity for the agent and still pull enquiry. Install prominent and neat signage where you are able to. As for internet advertising, buy the best you can afford. Unless there are only a handful of listings in the suburb, a standard listing will see you off page 1 very quickly and once you are at page 3 or later you are wasting your time. You can get deals such as free enhancements and upgrades and you should consider these. The layout of the ad is also important. The caption which also applies to the signboard should be attention grabbing. “Fact / Warehouse” or “Shop or Office” are lazy. A caption is not easy but well worth the time spent. Borrow or reword headings that leading agents use if you must but avoid cliche. From time to time update the ad with a new caption or photo.

4.   Property features.
You need to highlight the key points. Avoid residential style War and Peace narratives. Often this is placed on an elevated board where you can barely make out the agent's number whilst driving by at speed, let alone discover that the property has two kitchen sinks. Highlight items such as position, size, condition of the premises, ideal user, key issues such as existing new fitout and car parking. Secondary features which can be included but do not need to paint the primary picture are air conditioning, amenities, signage, state of fitout, NABERS rating if over 1000m2 in the case of offices. Springing heights, roller door numbers, heights, hardstand, canopies, power capacity, sprinklers and proximity to ring roads in the case of industrial properties. Grease traps, frontage, neighbours, signage, canopies, permits, any fitout in situ in the case of retail premises. You need a floor plan, zoning, a car park plan, details of service contracts, all outgoings and anything else you would need if were leasing it for your own use.

5.   Price.
If it is still at last year’s price then consider reducing it. If you have just completed a mild renovation and there is no interest then increase the price. The market is not perfect and tenants are not valuers. You need to do something different if you are not getting enquiry. If you are seeking $52,000 p.a. for example, consider $49,500 as any internet search by a prospective tenant looking in the range $40,000 - $50,000 will now capture the listing.

6.   Client Liaison.
Once you have put the listing up on the net, if you don’t call the landlord for three weeks, there is something very wrong. The best agents can usually keep in touch with clients weekly or daily if they have a hot prospect or an offer. Average agents struggle to keep in touch at least once weekly even if it is only via a brief email. Only you can decide which one you are. No landlord trying to lease their property ever said they were sick of the agent ringing all the time. Conversely, the landlord who rings every day or several times a day will make the agent as anxious as they are but will rarely achieve a better result.

Beware! A hidden trap in the 2016 R.E.I.V. Lease.

The R.E.I.V recently updated their standard commercial lease which was basically unchanged from 2003. Whilst there are several changes to the new document, one in particular needs to be considered carefully. It concerns the requirement of a tenant to give notice to vacate once the lease is three months from its expiry or has expired and has continued on a monthly basis.

Clause 22 of the lease states “If the tenant does not have an option to renew this lease for a further term or if having an option to renew does not exercise it in the required manner, then if at least 3 months before the term expires, unless otherwise agreed in writing” : sub clause 22.1 (v) states “ the landlord or the tenant may end the tenancy at any time by giving three months prior written notice”.

This clause is intended to compel a tenant who does not take up an option or is uncertain of their intentions, that they must give 3 months written notice and afford the landlord some time to relet the property. Previously, the lease only provided for one months notice in writing by either party.

At first glance this appears to be a win for the landlord. In practice it may not as it can create the following problems:

1. The tenant is not likely to have read the lease and when advised will be in a state of disbelief.
2. The tenant may claim that the clause is unconscionable and therefore unenforceable. A claim against the landlord may then ensue or an offset is sought.
3. If the landlord had intended to rely on this clause then a tenant may claim it should have informed the tenant 3 months out from the expiry of the lease or when the option renewal notice (if any) was issued.
4. The tenant may simply vacate after one months notice and refuse to pay any further. Unless the security deposit is substantial, losses will be incurred.

For landlords and agents this could be the end of what was a good relationship with the tenant, legal
action and loss of reputation.

This is not the end of the matter. The leasing agent appointed may be unaware of the notice provision and proceeds to lease the property assuming wrongly that one months notice is all that is required once a replacement tenant is secured. The sitting tenant may then turnaround and advise the agent upon receipt of notice that they need to give 3 months notice. The new lease with a new tenant is then not capable of performance and the agent and landlord risk being sued by, compensating or losing the new tenant.

How do agents and landlords protect themselves?
The following procedures are suggested:

1. When a property is first leased, if this clause is intended to be relied upon then include it in the conditions of the offer to lease. Then there is no doubt as to the intentions of the parties.
2. Consider reminding tenants of this clause in written communication concerning the exercise of option or intention to renew.
3. Ensure that the offer to lease and the lease itself with the incoming tenant includes a clause to the effect that the lease is subject to the existing tenant vacating the premises and that the landlord will not be responsible for any compensation arising.
4. Delete the clause from the lease.
5. Agree in writing a date on which the premises will be vacant up front with the sitting tenant.
6. Agents and landlords should read the existing tenant’s lease at the start of the leasing campaign.