Most motels in New Zealand operate by way of leasing and likely many other types of accommodation properties as well. One of the main reasons for this, could be that the return from the real estate investment (land and buildings) is considerably lower than that earned by the operator of the business.
The capital requirements to own a freehold going concern reduce the number of potential buyers and even where such is offered, it is often split and sold as the business and real estate investment separately.
Misinformation and myths
Advice on rent reviews is often sought, by both landlords and lessees. It seems that this subject is fraught with myths, misinformation and general lack of knowledge around the process. Comments in this article relate to the writer’s observations in regard to most motel leases and generally long term commercial leases for accommodation properties. There will always be variables.
Rent reviews are normally two yearly. The right to review the rent is not necessarily a right to increase the rent. The lease will outline a fairly robust process to be followed, intended to protect the rights of both parties.
The landlord/lessor should first issue a notice specifying the rental amount that they deem to be appropriate as from the review date, the lessor’s notice. (The review date is specified in the lease.) The motelier/lessee must respond to the lessor’s notice within the prescribed period. If the lessee does not agree with the rental figure set, it is very important to respond within the prescribed period otherwise the lessee may be deemed to have accepted the new rental figure. The lessee’s notice in response, should state the rental they believe to be fair, or if they believe the rental should either stay as it is or possibly even drop if the lease has a “soft” ratchet clause. (More on ratchet clauses later.)
The review process is usually able to be commenced no sooner than three months prior to the next review date, although that can vary. If the rent review date passes without such notice, it does not usually prevent the lessor from serving notice at a later date. The lessor can give notice to review the rent for the applicable review date right up until the date of the following review. Some leases stipulate that if a new rental figure is determined, it can be backdated to the earlier review date, even if the review process is carried out considerably later.
Written record protection
Others say that if the review is carried out more than three months after the review date, then any increase determined can only be backdated to the date of the lessor’s notice. So, if your landlord agrees that there is no justification for a review (increase) it is important to get this in writing. If the land & buildings change hands prior to the next rent review and there has been no such written record, it has been known for the new landlord to instigate the rent review.
Leases often state that the lessee must pay the rent stipulated in the lessor’s notice until the outcome is determined, usually provided that the lessor’s notice is supported by a registered valuer’s report. For this and other reasons, it pays to keep the process moving to an early conclusion if possible. If disputing the rent, a valuer may need to be appointed by the lessee. Some leases provide that if the one party does not appoint a valuer within a certain time, the single valuer appointed by the lessor (or the lessee as the case may be) will become the sole valuer whose decision will be binding.
If two valuers are appointed and cannot reach agreement, then arbitration may follow. This can be a protracted and costly process and if feasible, is best avoided. (Costs of the arbitration may be apportioned to the parties by the valuers at the conclusion of the process.) Ideally the first strategy in these situations should be to try to find the path of least resistance. In other words, having a meeting to discuss the rental and see if some common ground can be found. If successful, the agreement should be recorded in writing. A variation to the lease can be registered to record the new rental, however this may not always be necessary provided it is otherwise clearly documented.
Twin timing matters
Two other matters around timing. As reviews usually come around every two years, it may well coincide with the lease going on the market. A purchaser is not likely to want to enter straight into a rent review and so it pays to anticipate this if selling. The other thing to keep in mind is that the rent review time may be a good opportunity to seek (if necessary) a lease extension.
Often lessees are approaching lessors, seeking a lease extension when trying to sell, without any real bargaining chips in hand. Obtaining a rent increase is quite valuable to a landlord, not only because it increases their income but also the value of their land & buildings quite significantly. At a yield of say 7.5 per cent on commercial real estate, every dollar of rent equates to over $13 of capital value. For this reason, if conceding to a rental increase it would be a good idea to try for a lease extension on favourable terms in return for putting the review to rest.
This article addresses just the process. In the next edition of AMG we discuss the calculation of market rental, relevance to turnover, ratchet clauses, etc.
It must be stressed that the contents of this article are not to be construed as technical and/or legal advice. One should always seek professional legal advice in matters around property and particularly commercially complex areas such as this. We are more than happy to receive enquiries about this matter and offer advice where we can.