A retrospective market rent determination can have a big impact on someone’s hip pocket – either the landlord or the tenant – and will they live happily ever after?
Market rent reviews are supposed to occur within the timeframe stipulated in the lease. On the odd occasion, these timeframes are missed; sometimes leaving the rent review uncompleted for a considerable period. The financial impact can be considerable for one of the parties to the lease, either the landlord or the tenant.
A standard market rent review clause would require the landlord to provide notice of market rent. Should the tenant disagree with the market rent, the clause usually provides for a determination of it by a registered valuer. The lease may provide for the landlord and tenant to jointly appoint the valuer, but if the parties cannot agree, the appointment is made by the nomination third party.
In Queensland, it may be either the President of the Queensland Law Society Incorporated or the Australian Property Institute or, in the case of a retail lease, by the Registrar of the Queensland Civil and Administrative Tribunal (QCAT).
If the market rent review is missed, what is the time-period before the opportunity to conduct it lapses? If there is no stipulation in the lease, the answer to the question is six years, according to lawyers at a recent seminar I attended.
What is the consequence of missing a market rent review?, And which party to the lease is affected?
The consequences vary due to the situation. It may occur that the rent was above or below market at the time the review was to apply.
If the rent was significantly above market and with the compounding effect of annual rental increases, the landlord will be significantly out of pocket in reimbursing the tenant for the excessive rent charged.
- Scenario 1: The passing rent was $200,000 pa, but market was $125,000 pa. Annual rent increases by 4% and the market review should have occurred three years prior. The difference between passing rent and market rent is $84,364. An unhappy landlord as they must reimburse this amount.
- Scenario 2: In this situation, the lease term is 10 years and market rent is 50% of the passing rent at lease expiry. Annual rent of $200,000 pa compounded at 4% over 10 years is $284,662 pa by lease expiry. The market rent is $142,331 at commencement of year 11, the making of a very disappointed landlord.
One can imagine (or calculate) how these numbers are exacerbated in either scenario if the passing rent was $400,000 pa or $600,000 pa.
What if the rent was significantly below market? Using the same assumptions as above, but in reverse order, under Scenario 1, the tenant must payment $84,364 in addition to their ongoing rent payment and continuing performance of their obligations expressed in the lease. In respect to Scenario 2, they must pay market rent or vacate the premises. In either case, an unhappy tenant.
The outcomes are obvious: either the landlord or tenant are affected, and their relationship may never be the same.
The lessons are:
- Missing a market rent review either by design or unintentionally can have major impact when made retrospectively.
- Leases with long terms and no market reviews can create unsatisfactory financial consequences at lease expiry.
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