Reframing ratchet clauses in lease agreements

Ratchet clauses in commercial property leases are something tenants love to hate.

That’s not surprising because the implication is that with a ratchet clause, rents always go up at the time of a rent review.

The ratchet clause in a lease is often that; a set in concrete element of the lease that means landlords can and will automatically ratchet up a rental when it is time for the lease to be reviewed. Just this week I was told by a tenant that the landlord was trying to claim a 30% increase in the rental!

Fear Not the Ratchet Clause
But that need not always be the case. I always tell tenants not to live in fear of the ratchet clause, because with the right professional advice there is always the potential to negotiate a mutually beneficial solution.

It’s important for a start to look at the landlord’s motivation. He or she will often be under pressure from banks, investors and the market to make sure rentals go up each time the rent is reviewed.

But that’s the conventional wisdom isn’t it? We always expect rents to rise, along with the price of everything else.

Most leases contain a method by which the parties will decide on the current market rent at the rent review time. The core of this method is a clause called the “ratchet clause”.

Hard Ratchet Clause
There are two types of ratchet clause. The hard ratchet, like a socket wrench, will only ratchet in one direction… up.

Soft Ratchet Clause
Then there is a soft ratchet clause that can allow a rent to fall, although not below the commencement rental.

There are other rent review methods too, such as the “CPI indexed” rental method. I will deal with this method in another article.

In this market where there is a glut of vacant commercial property to lease, landlords are particularly keen to keep their buildings tenanted. They don’t want to risk losing tenants who are angry at rental increases via the ratchet clause.

So tenants and landlords have some good room to negotiate. Yes, even if there is a ratchet clause.

I help tenants work with their landlord to find a solution that works for both parties. It is often a point of negotiation to agree to a rising rental via the ratchet clause, but ask for a number of trade-offs that can be carried out at the landlord’s cost.

Over the last year, I have negotiated for our tenant clients more and better carparking, improvements to the property, and a range of other advantages that improve the tenant’s position in the premises.

Meanwhile, the landlord still ends up looking good to financiers and investors because they have achieved a rental rise, or at the least, maintained the value of their investment.

Fine Print
It is all in the fine print and knowing where potential gains are lurking. I am one of the few people who LOVE fine print!

I advise you to take the fear and loathing out of ratchet clauses and start to see them as a starting point for a negotiation.

And if you have a rent review coming up this year, I’d be happy to discuss how you can get a better outcome. Feel free to give me a call.