New Office Developments and Pre-Leasing via an Agreement for Lease BY PAUL NELSON
There is around 25,000,000 m2 of office space in Australia (PRP Research) both in the CBD and suburbs and new developments are all the go, now the markets have tightened and face and more importantly effective rents firmed in the past few years, so how do you lease up a new development (pre-commit).
Legally you cannot pre-lease something that doesn’t exist but once you have a design and a DA marketing usually begins and pre-lease commitments are sought. To legally achieve this lessor and lessee enter into a Deed of Agreement to Lease or more commonly known as an AFL (No not Aussie Rules).
An Agreement to Lease or AFL is a Deed outlining the parties intentions and provides a detailed scope of the building to be built including the leased areas with tech spec’s and plans and then a pro forma lease which is completed as far as terms can be but excludes the net lettable area and the actual rent but does specify the rate pm2pa. The terms that can be completed are: -
- Premises (proposed)
- Rent pm2pa
- Rent review pattern
- Outgoings covered but not %
- Make Good
The deed authorises the lessors solicitor to complete the “blanks” once the NLA is known from a net lettable survey (NLA) which covers: -
- Rent per annum
- Outgoings %
- Rent commencement
The rent commencement is almost always triggered by a clause re Practical Completion (PC) which is when the building meets the criteria laid down in the AFL normally when it is practical to occupy and an Occupation Certificate (OC) has been issued. PC is fraught with many issues but more on that later.
What about Incentives you ask? Well most of the time this is done by means of a side deed which is a private agreement between the parties and not registered with the lease so as to keep the deal “secret.”
Incentives given are the usual in the market place: -
- Gross or Net Rent free
- Fit-out contributions
- Reduced rental
Incentives are usually also triggered by the PC although some are payable on the tenants Occupation Certificate (OC) such as fitout contributions.
An AFL will contain a Deed of Agreement and attached to that will be a host of details about the building which have to be built by the lessor and accepted by the lessee at completion as being what was promised in the Agreement. Appendices might include: -
- Floor plans with approx. net lettable areas
- Reflected ceiling plans
- Car parking arrangements
- Full tech specs of the building
- Architectural details inc. finishes
- External façade details
- Proposed sustainability credentials
- Common facilities inc. End of Trip
Also detailed processes for any changes to the spec, an approximate timetable for completion, processes for changes to the timetable and details about how defects will be rectified and in what time frame.
Because the building is usually not under construction at the time pre-letting is done timing is critical and an accurate forecast for PC is needed to meet with tenants’ expiries and vacating times. On the other hand, a lessor needs to have some flexibility with construction as this is a difficult process too. An AFL will therefore have an estimated PC date therefore and a sunset date (when the deal falls away) and some flexibility for extending PC.
Logically a tenant’s fitout should be integrated with the construction of the base building but there are issues with this especially with procurement governance for the tenant and if by a separate contractor WHS issues with 2 contractors on site which could even end up with an industrial dispute. So, if a lessor offers you part of the incentive as pre PC access for fitout make sure the process is clearly documented.
Occupation Certificates (OC’s) are issued by Building Certifiers or Private Certifying Authorities (PCA’s) although Councils still do some work especially residential. The recent Opal Tower structural issues and flammable cladding on the Lacrosse Building have brought PCA’s under special scrutiny although cut throat pricing and lack of independent engineering certification are also part of the issue.
A PCA will therefore look very carefully at all the certificates of completion for all aspects of construction and especially essential services and any fire engineered solutions which are inevitable in modern complex buildings. Instead of a process over a few weeks it has become a process of many months of pre-PC/OC checking and re-checking which in turn can impact on the presumed timeframe. Because a PC/OC is so critical in the Development process its important to get it right but also get it within the forecasted time to allow the tenant possession.
In the pre-PC phase, the tenant can get on with the design and procurement of a fitout but cannot usually start until PC of the base building. Even then it’s important to keep a record of defects in the tenancy area and a way of getting them rectified at some stage.
As you can see pre-leasing is fraught with difficulties especially on the pointy end when the tenants time frame becomes critical. Some pre-leases have been so critical to a development the tenants option in his existing building is taken on as a rental liability by the developer and the tail regarded as a development cost just so its guaranteed the sunset clause is not triggered in the AFL and the tenant ultimately moves albeit late to the new development.
So as you can see pre-leasing by an Agreement for Lease is not a straight forward process and you need a good understanding of the practical issues involved and good legal advice on the inevitably complicated documentation. When you are near PC you need construction management advice and be able to juggle all the issues around fitout, timing, PC/OC, moving and ensuring your company has “a home to go to” come what may.
Paul Nelson B.Sc. (Urb Est Man), EMBA, MRICS, LREA is a property professional with over 40 years’ experience in the UK, Hong Kong and Australia and a member of the PCA Academy Property Asset Management Committee. He currently works for Knight Frank Newcastle.