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Make-good clauses come into their own

Innovative commercial solutions that suit both tenant and landlord should be the goal of any make-good agreement and with significant movement by occupiers being noted across market segments, repair obligations and other considerations when exiting a lease are coming to the fore.

Make-good provisions are found in most New Zealand commercial property leases and are supported by legislation and case law, with occupiers required to reinstate a landlord’s property by either undertaking physical works or through a financial settlement.

David Guy heads up the Bayleys building consultancy team and in the latest edition of Bayleys Total Property, said hand-in-hand with relocations comes an appreciation of the costs involved with any make-good or reinstatement obligations on their current leased space.

“Make-good obligations can be a significant cost consideration and some clients overestimate these, some woefully underestimate, while others have made no provision to address make-good costs at all which can impact business continuity and create conflict with the landlord.”

Guy stressed that occupiers should get a detailed Premises Condition Report before signing a lease as this time and date stamps the state of the building for reference at lease end, hopefully mitigating any friction.

“The purpose of a make-good clause is to protect the landlord from having to pay for repairs that were caused by tenant negligence or use of the property.

“In the current market, commercial landlords generally prefer financial settlements as these allow them to decide on the scope and extent of works best suited to maximise future rental returns on their property.

“Tenants, meanwhile, are keen to minimise their financial exposure to make-good claims, and in some cases are looking to reduce their residual leasehold repair costs by assigning or sub-leasing surplus space.”

Experienced landlords tend to be highly aware of the value of make-good within their lease portfolio, and major corporate occupiers are generally well-advised and mindful of the full extent of their leasehold repair exposure.

“However, smaller businesses are all too often blissfully unaware of the potential sting in the tail that waits at the end of their property lease,” cautioned Guy.

“While property leases generally include provisions for dispute resolution, they are expensive to implement and tend to take a long time to resolve.

“With the right advice, fair and reasonable make-good settlements can be agreed in good faith, and should include innovative commercial solutions that fit the needs of both parties.”

In the industrial leasing market, Bayleys national director industrial and logistics, Scott Campbell said ordinarily under a make-good clause, all racking, plant and machinery would be removed, flooring returned to original, and any office space associated with warehousing reinstated to the condition it was in at lease commencement.

“However, some building owners are prepared to negotiate with the outgoing tenants to take over fitout to make the property more attractive for reletting.

“This relies on a tenant being fully across costings but can bring efficiencies when navigating an exit from one property to another.”

Bayleys national director retail, Chris Beasleigh said the level of make-good in the retail leasing market generally depends on the type of retail business involved and the degree of fitout specialisation.

“For more bespoke retailers, a lease is likely to contain a detailed make-good provision as any fitout installed would be unique and not transferable to an incoming tenant.

“With hospitality venues like restaurants though, agreement may be reached on leaving extraction, kitchen and bathroom fitout and air-conditioning in place as they could be used for the next tenant.”

Bayleys national director office leasing, Matt Lamb said the trend towards occupiers wanting turn-key, fully-fitted office space is largely negating make-good obligations as the fitout belongs to the landlord.

“Fair wear and tear provisions still apply, but the cost of fitout to an occupier is really driving demand for plug-and-play space that is fully kitted-out and easily transferrable to a new tenant.”

Platform Group provides independent project advisory for a wide range of clients and specialises in commercial office, workplace design and independent project/cost management services.

Managing director, Jeff Cowan said for relocating tenants, Platform can assess any liabilities with their existing tenancy including costs of physical works needed to be undertaken in accordance with their original lease’s make-good or reinstatement obligations.

“As third-party advisors, we can clearly assess obligations under the lease to support parties’ agreement on works to be fulfilled, or suggest an amicable cash settlement arrangement which is an increasingly preferred option.”

Cowan said as a generalisation, tenants will tend to take a conservative position on costs to reinstate, while landlords would take what he calls an “optimistic” approach at lease end, with agreement reached somewhere in the middle.

“If the tenant has had a significant lease term and the fitout is somewhat dated and inflexible, then it’s less likely there’s residual value for the landlord in terms of its intrinsic worth to new tenants.

“Cash settlements are more likely for A-grade space with modern fitout suited to today’s working styles that could easily transfer to an incoming occupier, whereas a landlord would tend to want the occupier to fund reinstatement to base build for a C-grade tenancy.”

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