Market rent review: mechanism, pitfalls & how it works?

By Don E Gilbert Queensland Lease Consultants © May 2003 published in an industry magazines in 2000 and 2003 Peer Reviewed by friend colleague mentor and Tribunal Member of QCAT Malcolm Macrae

In this article we will cover:

The importance of the market review;
The process; and
How the process and outcomes are sometimes subverted?

The Australian Property Institutes Guidance Note “GN 34” (draft) entitled “Assessment of Market Rental Values – Retail” defines Market Rental Value as “the estimated amount for which an asset should rent, as at the relevant date, between a willing Lessor and a willing Lessee in an arms’ length transaction, wherein the parties has each acted knowledgeably, prudently and without compulsion”, and having regard to the usual terms and condition for leases of similar assets”. (Gilbert, D. 1995) adopted into IVSC (‘International Valuation Standards’ Council) 2000 # Note 3/2/2019

This definition arises from important case law. #Note 3/2/2019: this is a critical definition subsequently teased out by me and presented in 16 International Papers and articles on LinkedIn. If the market rent (a challenging figure to evaluate) is WRONG; and a subsequent multiplier used to value capital value is WRONG, the two incorrect values aka the product of the multipliers can exaggerate the error. Also see:

https://www.linkedin.com/pulse/evaluating-reasonable-rent-one-retail-lease-don-gilbert/

Section 29 of the Retail Shop Leases Act of Queensland assumes the shop is vacant; it is available for leasing; the rent that would reasonably be paid for the same or substantially similar use under the lease; that the rent is to be determined on an effective rental basis (taking all incentives such as rent free periods into consideration); to ignore lessees’ goodwill or fixtures and fittings; on a gross rental basis (including outgoings); and to consider submissions from both parties.

Under a lease and in the absence of an agreement between the parties, a specialist retail valuer is appointed to determine the rent.

The market review if carried out properly is equally important to both parties; to the lessor and lessee for obvious reasons. One of the pitfalls is the lack of certainty of outcomes and so some lessees try to avoid them.

An important consequence of rent levels well above the market rent, may result in a Two Tier Market existing in the shopping centre industry and gross misrepresentation (or even misleading and deceptive conduct under the Trade Practices Act) of asset value to supernatants and other “investors”. These have important implications for those in fiduciary positions representing major corporations in this country.

The process

Ideally leases should provide for a market review during the term of the lease or at the renewal of an option. Review periods should not be more than about three years to provide an adjustment mechanism, where open market forces and/ or decisions regarding tenancy/competition mix affect the tenancy for better or for worse.

The lessor is required to notify the lessee in writing of what it considers the market rent to be. The lessee must respond that it accepts or rejects the lessor’s notice in writing within the time frame.

The parties then typically agree on a valuer. Failing agreement the Registrar of the Retail Shop Leases Tribunal appoints one.

Subverting the process

The market review process can be subverted by:

An inadequate time frame for the lessee to seek advice and respond to the lessor’s notice.
A much longer time frame sometimes “at any subsequent time during the lease term”.
Leases may provide that the lessor “may” or “must” notify the lessee what it considers the market rent to be. There is an important distinction between “may” and “must”. In this context it seeks to give the lessor the benefit of choice the benefit if the “market” has risen – or to avoid a reduction if the market rent has fallen.
If the lessee responds “out of time”, the lessor’s unsubstantiated assessment is taken to be the market rent and rent payable. If the lessee disputes the rent, this can be resented by some lessors and may impair the relationship and put the lessee’s business at risk.
Failure by the lessor to provide evidence of its assessment either in the notice or during negotiations.
An assessment that reflects the “deprival value” to the lessee rather than the market rent on the required assumptions.
Reference to historic passing rents of similar or different uses in different premises or centres with different potential or lease conditions.
An assessment that has little or no regard under market change or the specific trading conditions of the lessee.
Failure to consider the effect of unnecessarily onerous lease conditions.
The increasing tendency of parties to dispute valuer’s determinations, which threatens the whole process.

Conclusions

A fair market review notice should incorporate the following:

An adequate but specific time frame for the lessor to give the lessee written notice, say not later than three months prior to the review date.

The proposed rental of the lessor should at least be supported by evidence, which would stand the test of comparability and comply with Section 29 of the Retail Shop Leases Act.

A reasonable time frame requesting the lessee to respond in writing or to meet to discuss the lessor’s assessment.

Such a process would produce informed outcomes and ensure procedural fairness and openness. It would also assist valuers, knowing the party’s intent is one of objectivity rather than opportunism.