When running a retail business in Australia, if you need to lease business premises, you will generally need to enter into a retail lease. Under the Retail Leases Act 1994 (NSW), a retail lease begins when a person starts to occupy a retail shop or begins paying rent as the tenant under the lease. The following focuses on retail leases and the key considerations around renewal options.

What is a retail lease?

A lease is a contract that sets out the rights and obligations of the property owner (the landlord or lessor) and the individual or entity (the tenant) who will occupy the premises. A retail lease specifically refers to the lease of business premises that can be used to sell goods. These shops are typically located in shopping centres and are protected by each state’s retail leasing legislation in Australia.

How does a retail lease work?

A retail lease will include an initial fixed term, which is the minimum period you, as the tenant, will lease the shop. Generally, this minimum term is 3 years, 5 years, or 7 years.

A retail lease may also include an option to renew or extend the lease (Option). If there is an option, it is an agreement negotiated between the lessor and the tenant before entering into the lease.

What should you know about retail lease options?

An Option gives the tenant the right to obtain a lease for a further fixed term on the same terms as the existing lease. The rent will usually change according to a pre-determined method, and there will be new start and end dates. For example, if your initial fixed-term retail lease runs from 1 July 2021 to 30 June 2024 (i.e., 3 years), then your option to renew for a further 3-year term would cover 1 July 2024 to 30 June 2027.

If the lease provides for a renewal option, the tenant has the right, under that option, to require that, after the initial lease term ends, the lease continue for a further period on the terms of the initial lease (excluding rent and term). For example, a 4-year initial lease may provide for a 4-year renewal option; if the tenant exercises the option, the tenant will have a total term of 8 years.

However, if the lease does not provide for a renewal option, then once the lease ends, the lessor may enter into a new lease with the tenant on terms that may differ from those of the initial lease, or the lessor may lease the premises to another tenant.

We recommend carefully reviewing your lease to confirm whether you have an option and what you must do to exercise it.

It is particularly important to remind you, as the tenant, that you must keep a careful record of the date for exercising the option, or in other words, the deadline for exercising the option. The lessor is not required to remind the tenant or send them a notice about the deadline for exercising the option. This deadline is most commonly 1 month or 3 months before the end of the lease, not on the last day of the lease.

The deadline for exercising the option will usually fall before the end of the fixed term specified in the lease. If the tenant wishes to exercise the option, they should notify the lessor in writing before the deadline. For another example, if the last day of the initial 3-year fixed term is 30 August 2023, the deadline to exercise the option may be 30 May 2023. However, the deadline specified in each lease may differ, so you should check your own lease carefully.

Options are particularly useful when the tenant is uncertain about how long they wish to continue leasing the premises after the initial fixed term. For example, if a tenant has a 3-year fixed-term lease with an option to renew for a further 3 years, the tenant can exit the lease after 3 years by not exercising the option.

About exercising the option

First, it is important to note that the tenant has the right to require the lessor to grant them a new lease on the terms originally agreed. The tenant should ensure that they have performed all obligations under the lease and notify the lessor in writing that they are exercising the option.

It is critical that the tenant exercises the option before the deadline. If the tenant is late or provides incorrect notice to the lessor, the tenant will lose the option and will need to renegotiate a new lease based on market conditions. If the tenant wishes to continue renewing the lease, this could result in the tenant having to compete with other potential tenants.

Under the Retail Leases Act 1994 (NSW), if exercising the option requires a “market rent review”, the tenant can request an early determination of the market rent. This can help the tenant decide whether to exercise their option.

The tenant may request an early determination of the market rent, no earlier than 6 months before the option deadline and no later than 3 months before the option deadline. If the lease term is 12 months or less, the tenant may request a rent determination no earlier than 3 months before the deadline, or no later than 30 days before the deadline. Although the lessor is not required to notify the tenant of the option deadline, the lessor may wish to know before the deadline whether the tenant intends to renew, in order to plan ahead.

Please note that once the current market rent is determined, the tenant will have 21 days to exercise the option.

Final thoughts

Whether it is a retail lease or any commercial lease, there may often be clause traps or risks that need to be avoided. Both lessors and tenants in the retail sector should understand the various requirements and rules of the retail leasing legislation in relation to their lease terms. In addition, they should understand the consequences of non-compliance with retail leasing legislation. In certain circumstances, the tenant may have the right to terminate the contract early or obtain compensation. If both parties wish to build a long-term cooperative relationship, including a renewal option in the lease is a win-win arrangement, and the lease should specify in advance the conditions for the tenant to exercise the renewal option and related matters, in order to avoid unnecessary disputes. If you encounter legal issues relating to a commercial lease, we recommend seeking assistance from a qualified lawyer.