Thursday, 9th of November 2023
Retail Vs Non-Retail Commercial Tenants – What’s The Difference And Why It Matters
Understanding the intricacies of commercial property leasing is vital for any property owner given the biggest risk for commercial property owners is occupancy rates. Among the most fundamental distinctions is that between retail and non-retail tenancies - a crucial differentiation that affects both legal considerations and financial implications for landlords and tenants alike.
In this article, we will outline the distinction between these two tenant types, and why, as a commercial property owner, you should be careful when drawing up a contract for either.
The Different Types of Commercial Property
In the dynamic landscape of commercial real estate, properties come in all shapes and sizes, each serving a unique purpose in the market. From bustling retail storefronts to sprawling industrial complexes, the classifications of commercial property are diverse and multi-faceted.
The main types of commercial property are:
- Office Spaces: These can range from individual suites to entire floors or buildings.
- Retail Properties: Ranging from standalone stores to shopping centres.
- Industrial Properties: Properties used for manufacturing, production, storage, and distribution. These might include warehouses, factories, and industrial parks.
- Commercial Land: This involves vacant land intended for business use and development.
- Mixed-Use Buildings: Properties that combine residential, commercial, and sometimes industrial spaces.
- Hospitality Properties: This includes hotels, motels, resorts, etc.
- Special Purpose Properties: These are facilities like gas stations, car washes, schools, or medical centres that serve a specific purpose.
The Different Types of Lease Agreements
There are 2 types of Lease Agreements that can be used with commercial property: a Retail Lease and a Non-Retail Lease. The distinction between retail and non-retail leases is primarily based on the nature of the business operating in the premise (i.e. what the business will be doing).
This difference is significant because retail leases are subject to specific protections and obligations legislated in the Commercial Tenancy (Retail Shops) Agreements Act 1985, which do not apply to non-retail commercial leases.
Below is a brief summary of the key differences.
Definition and Coverage:
- Retail leases pertain to premises used wholly or predominantly for the sale of goods by retail or the retail provision of services.
- Any premises in a Retail Shopping Centre carrying on a business.
- Specified business in the Regulations - dry cleaning, hairdressing, beauty therapy and treatments, shoe repairs, sale/rental of DVD, electronic games or similar.
- Premises with a lettable area greater than 1,000 sqm.
- Lease agreements held by a listed corporation (i.e. listed on the ASX)
- Lease prescribed (ATM and vending machines).
Legislative Protection: Tenants under retail leases have more extensive legislative protections. The Act requires transparency and mandates that landlords provide tenants with specific documents (like disclosure statements) and information about outgoings and other expenses.
Rent Review and Operating Expenses: There are restrictions on how and when a landlord can increase rent, and tenants often have more rights concerning operating expenses and promotional levies. The Lessor pays the management fee, legal fees and audit fees.
Lease Term: The Lessee is entitled to a minimum of 5 years regardless of what the Lease Agreement prescribes as the Act will override any prior agreement and be contradicted.
Dispute Resolution: The Act provides mechanisms for cost-effective dispute resolution through the State Administrative Tribunal, offering an accessible avenue for resolving conflicts.
Definition and Coverage: Non-retail leases involve premises used for other commercial purposes, such as offices, industrial sites, or certain warehouses, which do not engage in retail provision of goods or services.
Legislative Protection: These leases are not covered by the Retail Shops Act and thus do not qualify for the additional protections embedded in that legislation.
The terms are largely dictated by the lease agreement, the negotiation between lessor and lessee and the general law of contracts.
Rent Review and Operating Expenses: Conditions for rent reviews and recoverable operating expenses in non-retail leases are more subject to negotiation and agreement between the Lessor and Lessee, with fewer legislative restrictions. The tenant pays the management fee, legal fees and audit fees.
Lease Term: There are no restrictions on the length of the Lease and will be dictated by mutual agreement.
Dispute Resolution: Disputes are typically handled through the court system or via private mediation.
Understanding these differences is crucial as it affects the rights and obligations of both tenants and landlords, impacting negotiations, lease management, and dispute resolution processes.
Structuring Your Contracts To Stay Cashflow Positive
When it comes to structuring your commercial lease agreement, it is imperative to consider all of the above differences when drawing up your terms and sourcing either a retail or non-retail tenant. This can drastically affect your bottom line in terms of profitability – this is something that commercial property owners often get wrong from the outset.
Another significant distinction to be made in the negotiations is whether the property is being advertised as gross OR net rent collections.
- Gross rent is the total collections a tenant pays, which includes property expenses (rates, land tax, strata fees, management fees, inspections etc.).
- Think residential property where the Lessor profit is determined after all bills have been paid.
- By nature, this will fluctuate monthly based on when property expenses are due for payment.
- As property expenses increase over time (due to inflation) the owner absorbs the increase. Naturally, the profitability decreases, as a higher percentage of the gross collections is used to pay the expenses.
- Net rent is the collections a tenant pays excluding property expenses (rates, land tax, strata fees, management fees, inspections etc).
- The total collections the tenant is liable for typically include rent and any reasonable property expense the Lessor is obligated to pay.
- The Lessor's profit is the rent owed by the tenant. This will not fluctuate and is consistent and predictable cashflow for the owner.
- The property expenses are paid through the money collected by the agent referred to as outgoings, variable outgoings or budgeted outgoings. This is done by producing a budget for a financial year for all expected property expenses and charging the tenant equal monthly installments.
- An audit is done at the end of the financial year to ensure the budget matches the actual property expenses. Credits are typically credited to the tenant or carried forward to the following financial year whilst deficits are invoiced to the tenant to recover the shortfall.
- As property expenses increase over time (due to inflation) the tenant absorbs the increase and the Lessor's profitability is unaffected.
Lease With the Commercial Experts
Having worked with numerous commercial property owners, the Perth Property Management Commercial Team understands the unique differences between retail and non-retail contracts and can assist you in drawing up a perfect contract that will keep your business cash flow positive, whilst mitigating your risk.
Understanding the differences between retail and non-retail tenants is paramount for commercial property owners seeking to optimise their investments. By tailoring lease agreements and property management strategies to the unique needs of retail and non-retail tenants, property owners can foster positive tenant relationships, attract reliable businesses, and achieve long-term success in the dynamic world of commercial property management.