Here’s a common scenario… Nutshell is engaged by a commercial property investor to find a tenant. We do what we do best, and a prospective tenant is found, and lease terms are agreed upon. At this point, it’s common for us to hear the question “What kind of guarantees do I have that this guy is going to pay his rent?”

It’s a fair question. Our answer: The Three Layers of Landlord Protection.

Landlord Protection #1 – The Lease

A Lease is a written contract between Landlord and Tenant. The Landlord agrees to provide a land and a building. In exchange, the tenant agrees to pay a certain sum of money. Obvious, I know.

However, it’s important to remember that a lease is a contract. Just like any other business contract. If a tenant agrees to pay you $5000 per month for the next 5 years, they are obliged to do so by law. If they fail to do so, your contract—i.e. your lease—will allow for you to repossess the property. Furthermore, you will be able to take legal action* against the tenant for the remainder of the rent they owe. If it’s a long lease, this could be hundreds of thousands of dollars.

*As always when considering legal issues, speak to your lawyer!

Usually, a lease will be between two business. For the property owner, using an SMSF is common, or perhaps the property is owned by an operating business. For the tenant, the lease will usually be in the name of the business operating out of the premises. If the tenant is using a business to lease the property, we always do a credit check. This is a great way to spot any red flags, but it is not a form of “protection” itself.

Landlord Protection #2 – The Bond

On top of the protection provided by the lease itself, all Landlords should insist on a security deposit, also known as a bond.

A Bond is a sum of money that is set aside as security in case the tenant breaches their lease. A bond is usually equivalent to a certain amount of rent, say, 3 months. The form of the bond can be cash or a bank guarantee.

A standard bond clause reads something like this:

“The Lessor shall be entitled to deduct from that deposit, or apply that deposit in or towards satisfaction of, any amount that may be or become payable by the Lessee to the Lessor pursuant to the provisions of this lease.”

In layman’s terms, if the tenant fails to pay their rent or damages the property, a landlord can use the bond to repay themselves.

If you are at the point of damaged property or unpaid rent then it’s most likely the lessor/lessee relationship has broken down. And therefore, you don’t want to be chasing them for money. Much better to have it set aside from the beginning.

Landlord Protection #3 – Personal Guarantees

So far you have an iron clad contract that guarantees the tenant company will pay their rent. You also have a security deposit set aside in case they don’t pay their rent. The 3rd and final layer of protection are personal guarantees.

A Personal Guarantee is a guarantee, which is written into the lease, that the directors of the company are personally responsible for following the lease. That is, even if the tenant company fails to pay their rent, or goes bankrupt altogether, then the directors are still responsible for paying the rent and following any other terms of the lease.

Here’s an excerpt from a standard commercial lease (edited for clarity):

“The guarantor named in Item 11 guarantees to the Lessor the due performance by the Lessee of the Lessee’s obligations (including obligations to pay rent or damages) under this lease both during the term of this lease and after that term has ended…

If the Lessee does not pay any money payable to the Lessor by virtue of this lease (including rent and damages or compensation following default) then the guarantor will pay that money to the Lessor on demand.”

Unfortunately, you won’t always get personal guarantees from company directors. A local business with an owner operator will usually give a personal guarantee. But can you imagine the directors of KFC personally guaranteeing a lease on a small store in Sydenham? I don’t think so! However, in the case of KFC or the like, you can have more confidence in the company itself to pay the rent, so personal guarantees become less important.

So there you have it. With these three layers of protection, you will seriously minimise your chance of losing money during a commercial lease. If you have any questions about your lease or a prospective tenant, we are always happy to chat. Get in touch here.

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