When a commercial property is sold with a tenant in place, the purchaser steps into the landlord’s position under the existing lease and takes on the rights and obligations attached to it.
The terms of that lease can directly affect the value and performance of the investment. Rent reviews, outgoings, option periods, incentives, guarantees and repair obligations can all influence the income the property generates and the responsibilities the new owner assumes.
Before contracts are exchanged, buyers need to understand how those provisions operate, what will transfer at settlement and where any potential risks sit. That review can reveal issues that are not always obvious from the property itself.
The lease sets the financial return, not the contract of sale
The rent stated in the lease is only one part of the financial position a purchaser needs to understand. It is also important to check how and when that rent will change, including whether reviews are based on a fixed percentage or market value and whether any limits apply.
The lease will also set out which property costs can be passed on to the tenant and which remain the landlord’s responsibility. Depending on the terms, this may include council rates, water, insurance and strata levies.
Any additional arrangements with the tenant should also be reviewed alongside the lease, as they can affect the income the purchaser will actually receive after settlement. A tenant may still be benefiting from a rent-free period, fit-out contribution or another concession agreed with the current owner, and those obligations may continue once the property is sold.
Where the premises are covered by the Retail Leases Act 1994 (NSW), additional rules can apply to outgoings. For example, there are limits on the amount of land tax that can be passed on to the tenant, and landlords must provide prescribed estimates and statements for recoverable outgoings.
Together, these terms help show what income the property is likely to generate and what costs the new owner may still need to meet.
Confirm whether the lease is retail or commercial
Whether a lease falls within the Retail Leases Act 1994 (NSW) can materially change the rights and obligations that come with the property.
Whether the Act applies will depend on how the premises are used and the type of business operating from them. It may apply where the property is used for a prescribed retail business or forms part of a retail shopping centre, while factors such as the size of the premises and the length of the lease can also affect whether it is covered.
If the lease is governed by the Act, the landlord and tenant must comply with a number of additional requirements. These can affect areas such as disclosure, rent reviews, outgoings, assignment of the lease and how disputes are handled.
For a purchaser stepping into the landlord’s position, confirming whether the tenancy is governed by the Act helps establish which lease provisions can be relied on and which statutory obligations will continue after settlement.
Lease security needs to transfer with the property
Commercial leases may be supported by security such as a bank guarantee, cash deposit or personal guarantee from the tenant’s directors. As part of the purchase, the buyer should confirm what security is currently held, who it is held in favour of and whether anything needs to change when ownership transfers.
Bank guarantees require particular attention because they are commonly issued in favour of the existing landlord. If the guarantee is not properly reassigned, replaced or otherwise dealt with before settlement, the new owner may later find that the security is not available in the way they expected if the tenant defaults.
The GST trap in a "going concern" purchase
A tenanted commercial property may be sold as a GST-free “going concern” under section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth).
In this context, a going concern generally means that the property is being sold with the existing leasing arrangement continuing, so the rental enterprise passes to the new owner as an operating arrangement rather than ending at settlement.
For the GST-free treatment to apply, certain requirements must be met. The purchaser must be registered or required to be registered for GST, the parties must agree in writing that the sale is a going concern and the property must continue to be leased through to settlement.
If these requirements are not met, GST may become payable on the sale, which can have significant financial consequences for both parties.
Check whether the lease needs to be registered
In NSW, a lease with a term of more than three years generally needs to be registered on title if it is to pass with the property and bind a future owner in the usual way. An unregistered lease may still operate between the original landlord and tenant, but its position can become more complicated when the property is sold.
That issue arose in Ideal Business Centres Pty Ltd v Violin Holdings Pty Ltd [2018] NSWSC 1249, where the property was subject to a ten-year lease that had never been registered. After purchasing the property, the new owner argued that it was not bound by the lease and required the tenant to vacate.
The tenant was able to enforce its rights under the lease because of the terms of the sale contract. The purchaser had agreed to take the property subject to the existing lease, which the Court found amounted to a promise to honour the tenant’s rights after the property changed hands.
The case shows that an unregistered lease does not simply disappear when ownership changes, but it can create a far less straightforward legal position for everyone involved.
Tenant default and the risk of repudiation
Responsibility for structural and capital works can become a significant issue for a purchaser, particularly where the lease places obligations on the landlord to maintain or repair parts of the building.
The High Court considered the broader consequences of serious lease breaches in Progressive Mailing House Pty Ltd v Tabali Pty Ltd (1985) 157 CLR 17. The tenant had stopped paying rent for several months and had also breached other obligations relating to repairs, use of the premises and subletting.
The landlord re-entered the property and sought compensation for the remaining term of the lease. The High Court found that the tenant’s conduct, viewed as a whole, amounted to repudiation and upheld an award of $85,000 in damages for the landlord’s resulting loss.
For a purchaser, the decision highlights why the existing landlord and tenant relationship matters alongside the physical condition of the property.
Getting advice before you buy
Buying a tenanted commercial property means taking on an existing lease, along with the rights, obligations and financial arrangements that come with it.
Before contracts are exchanged, it is important to understand how the lease operates, what will transfer at settlement and whether there are any existing issues that could affect the purchase.
At Aubrey Brown Lawyers, our Commercial Property team can review the lease and contract for sale, identify any areas that require closer attention and assist with the legal aspects of the purchase.
