BULKY GOODS + RETAIL SHOP LEASES ACT 9 NOVEMBER 2005 DETERMINATIONS UNDER THE RETAIL SHOP LEASES ACT ALLEN J CRAWFORD F.R.I.C.S. F.A.P.I. EXECUTIVE DIRECTOR CHESTERTON CORPORATE PROPERTY ADVISORS Today I will be providing to you an overview of the Determination Process under the Retail Shop Leases Act (“RSLA”) incorporating the Retail Shop Leases Amendment Bill. I will be concentrating on some of the pitfalls and suggested approaches to the Appointment of the “determining valuer”; relevant considerations including the relationship between market research / evidence the subject property the subject lease and business calculation of the determined rental; the determination report; preparations of submissions. Instructions Section 28 (2) “RSLA” states that the current market rent is to be determined by a specialist retail valuer agreed by the lessor and the lessee or, failing agreement, nominated by the Chief Executive. There is a major difference between a nomination and an appointment. The appointment does not occur until both parties agree to the terms and conditions of the determining valuer. While there is no prescriptive process on how a determination should occur, most determining valuers proceed along somewhat similar lines. On first being nominated, the valuer will contact the parties to set out terms and conditions on which the valuer is prepared to accept the appointment. This initial letter may also : request confirmation a dispute still exists; set certain time frames for the determination (I’m yet to determine a rental where the time frames I set, albeit seeming reasonable and in fact almost excessive at the commencement, have actually been met by the parties); detail information which will be required from each party to complete the determination including seeking submissions; seek Submissions from the parties; set the basis of the fees. I only accept fees in advance. I learned my lessons very early. The determination can favour one party or the other and in that instance you only receive payment by one party. If it is close to the middle, it is even worse because you have upset both and neither will pay your fees; provide an indemnity that both parties must sign It is relevant to discuss a couple of these in more detail ../2 -2- Detailed information and Submissions Sought Section 29(c)(i) of “RSLA” provides that a determining valuer must have regard to submissions by the parties. The lessor and lessee may each make a submission to the specialist retail valuer about the current market rent of the retail shop. The submission is to be made within a reasonable period nominated by the valuer. Any party making a submission, however, must under the Bill give a copy of it to the other party who then has an opportunity to provide a response. I see this is going to cause some problems in regard to confidentiality where submissions are made. Section 30(1) provides the determining valuer may request details from the lessor about leases in the centre in which the shop is situated. Section 26(2)(b)(vi) provides that a valuer requesting the information under Section 30 can be provided with the information without breaching Section 26 which imposes confidentiality limitations on the lessor in regard to information obtained. Section 35(2) deals with the confidentiality of the information, providing, that when detailing matters taken into consideration, the specialist retail valuer may disclose the information in such a way that does not identify a particular lease. There does not seem to be similar protection provided to the lessor unless information has been requested under Section 30 and there is no confidentiality of information provided by the lessee if it forms part of the submission. I suggest that the appropriate method is to treat the submission separately to the provision of information which, is more part of the independent research of the Specialist Retail Valuer. Indemnities Because of the nature of determinations, and the fact that parties to a lease have a different impression on the operation of the lease than stated in the lease, often one or both parties to the lease are disappointed with the result. This disappointment sometimes translates to aggression. Twice I have had complaints made about my determinations. In both instances the determination was investigated and reached the clear conclusion that the complaint was unfounded to the extent that the only reason one complaint was that the party did not like what they read and the second because I did not disclose confidential information. This is a costly process however litigation is far more costly and for this reason I am not willing to expose myself to unnecessary costs of defending groundless claims. I am disappointed with the Retail Shop Leases Amendment Bill which still leaves the valuer forced to seek this protection or be exposed to litigation no matter how diligently the determination was completed. Surely the same protection should have been given as has been done in the Arbitration Act and Family Law Act. Retail Shop Leases Act – The Process One Basis of Review Section 27 provides that only one basis of rent review can be applied at any particular review. Further it provides that the basis for rent review must be either: an independently published index of prices, costs or wages; or a fixed percentage of the same base rent; or a fixed actual amount; or the current market rent of the leased shop; or another basis prescribed by regulation; or a single basis formed by a combination of the others. The Act also allows for a basis of review to be related to the turnover of the business. The Bill excludes this provision for Major Lessees which are defined to be those lessees who lease 5 or more retail shops in Australia and for Section 27 gave a notice to the lessor, prior to entering into the lease, that they received appropriate financial & legal advice. ../3 -3- Where there is a provision in a lease that allows more than one basis of review at any particular rental review, it is the lessee’s option under Section 27(7) which basis to pick. You will find it surprising in going through leases how many leases do have more than one basis of review for a retail shop. It is not possible to contract out of those provisions of the Act. Early Determination The Bill includes a provision for the early determination of current market rent at option. The lessee may ask for the current market rent to be determined by giving written notice to the lessor in the “early determination period”. The “early determination period” means for a lease of not more than one year, the period starting three months before the option expiry day and ending one month before the option expiry day; or for a lease of more than year, the period starting six months before the option expiry day and ending three months before the option expiry day. The option expiry day is the last day on which the option to renew or extend the lease may, under the lease, be exercised. The current market rent must be determined as at the date the request is made to have the market rent determined not as at the review date for the lease, although of course you would not apply until the renewal date of the lease. The Act then further provides that the last day on which the option may be exercised despite what is said in the Lease is the earlier of: 21 days after the lessee receives written notice of a current market rent as determined; and the day the lease ends. Breach of Lease Terms The job is to also to determine the rental as if the lease and the law has properly been followed. The valuer normally should not have regard to either breaches of the lease or breaches of the Act. To do so, whilst also being a nonsense, would be to assume that breach continues for the remaining period of the lease. There are other remedies in the Act and the lease for parties to a lease to ensure the lease is followed. If the specialist retail valuer determines a rental assuming a continued breach and then that breach was remedied, the determination would then not be correct. Qualified Determinations A determination should not be qualified. I have known examples where the determined assessment was completed making certain assumptions. The determination is final and binding on the parties and the qualified determination is not appropriate. I am currently advising a client on one determination where one of the parties has decided that the determination was not assessed as a figure even though it was clearly specified so in the determination, but really was a rate per square metre. The lessor in this case has unilaterally come up with a new assessment of the area of the property albeit the net lettable area rather than gross lettable area retail and consequently includes areas that were specifically excluded from the sq metre area adopted by the determining valuer. Process of Valuation – Research of Market Comparables We know as valuers that inspection of the subject property, though critical, is a very minor component time wise. I am of the opinion that each comparable utilised requires similar scrutiny. This is in addition to the bulk of the investigated comparable evidence which proves unsuitable and is therefore rejected. Physical inspection of the comparables needs to be sufficient to identify the physical benefits and detriments. But it is not only the physical benefits and detriments that need to be investigated. Although it is often difficult to find complete details on the comparable evidence, if details are inadequate, the overall determination may also end up being inadequate. ../4 -4- Terms & Conditions The Australian Property Institute definition of value, provides that market rental value must have: “regard to usual terms and conditions for leases of similar assets” This is logical when capitalisation of market rental is considered. The research for the valuation however, must not only identify the property and gross rental but identify the terms and conditions under which that evidence was effected and hence to determine the “usual terms and conditions for leases of similar assets”. I have seen too many submissions and determinations which not only round the evidence but fail to identify critical terms and conditions. You need to find out, as a determining valuer, the actual rent, the actual lessor’s outgoings payable by the lessee, the actual term of the lease, the actual rent review provisions. A lease with a 5% annual increase will have a different market rent to a lease with, say, CPI rent reviews. The market rent review pure definition is the same – it may be that the evidence that makes the normal terms and conditions could be 5% annual but I would be applying a higher rent to the subject property if my lease only had CPI reviews, for instance. What Are You Valuing – Subject Property When training a new valuer I commence with the question “what is the first thing you should do when you arrive at a property to value it?” The answer is very simple – make sure it is the correct property. I can say with a fair degree of confidence that there would not be an honest valuer who has been round more than ten years who has not at least once, inspected the wrong property. Hopefully the right property was eventually valued. Valuing the right property includes full knowledge of all the benefits and detriments of the property. In a determination I have recently done, it came to a bit more than that. The property title showed only the lot itself and any search of the registered documents only showed that current lot. On this occasion the lessee also advised that he had two car parks. There was no legal documentation for these two car parks but, after intensive research, I uncovered the Body Corporate decision allocating the exclusive use rights. A few years ago I determined the current market rent for a coffee shop that had exclusive use area. The tenant’s adviser argued strongly that I had to disregard that exclusive use area. More recently a determination of a coffee shop was set aside because it did not take into account all benefits and detriments All benefits and detriments of the subject property and the evidence must be taken into consideration. Taking that one step further – with licensed areas to coffee shops – you will notice around the city now there is a lot of footpath dining. These areas are of benefit to the tenant and, in leasing the shop, that should be taken into consideration. Likewise, so should the rent that is paid to the Council. What Are You Valuing – Subject Business Permitted Use Section 29(a)(i) provides in doing a determination you must have regard to the same or substantially similar use. There are, critical differences between some uses that ostensibly appear to be substantially similar but the economic drivers of the business may be substantially different. Take the case of the difference between a newsagent and a sub-newsagent. Profit margins in the sub-newsagent are quite different to those in the newsagent. I have done a determination of a sub-news where the lease did not permit a newsagent only a sub-news. Therefore evidence of newsagents needed to have appropriate adjustment made to take into consideration the lower profit on selling newspapers and periodicals in the sub-newsagent ../5 -5- What appears to be the same use is not necessarily the same use when the business is properly analysed. Even with coffee shops, care would need to be taken between the coffee shop restaurant and the pure coffee shop business because the staffing and space requirements are quite different. Average Competent Operator An over-riding consideration has to be that the only reason that a prudent tenant would enter into a lease is to make a profit. When considering the business accounts it is necessary to consider if the profile of the operator fits the definition of the “average competent operator”. The correct process is to test whether the subject business profit and loss fits within the parameters expected of the “average competent operator” of that business and if not, to the extent necessary, that evidence must be disregarded. What Are You Valuing – Subject Lease Legality The role of the determining valuer when reading a subject lease is to determine exactly what was intended by the lease, provided that the lease is not contrary to law. Many leases do contain provisions that are contrary to law. From 1 January 1992, Queensland’s Land Tax Act prevented recovery of land tax from tenants. It is surprising how many leases still attempt to get around that provision of the law and, where that is done, how clumsily the attempt has been made. How many of us have seen Retail Shop Leases prepared on Commercial Tenancy Agreements. You need to envisage all leases clauses which are not contrary to the Retail Shop Leases Act and then add the required concepts under Part 6 of the Act to the extent that they apply to that particular tenant. Lease Epitome When the determining valuer has accepted the legality of the lease, an epitome is prepared detailing the relevant parts of the lease that actually impact on the rental value. Some include Rental review terms – the number of years between reviews Rental review methods – Outgoings – I find it quite amusing the acceptance in the market of the term net rent. Does net rent mean rent plus rates and taxes, insurance, repairs and maintenance, management, electricity in common areas, air conditioning maintenance and/or power, sinking funds or other sundry items. The items the lessee is responsible for need to be specifically identified and costed. The term of the lease can also have quite some bearing. Firstly does the lease require assumption of the period remaining on the lease or the whole of the lease term. Different rents can apply if you are looking at a two year assumption compared to a ten year assumption for the same property. In some cases there may be a premium in some cases there may be a substantial discount. It doesn’t necessarily mean there is a difference, but it is a very relevant fact to be regarded by the valuer. Make good clauses are another subject that seem to be forgotten. It is a large expense if, at the end of a lease, a make good is required. Some leases may provide for repainting, others may be to reinstate the premises or others may to strip everything out and demolish to how it was at the start of the lease. I have just negotiated a lease in which the requirement is, to paraphrase “strip everything out except for anything that may be of use to the lessor”. Other benefits and detriments under the lease. ../6 -6- Management Accuracy It is incumbent on the determining valuer to verify the information provided by the parties, as actually occurring, is a reflection of the actual commitment under the lease. I find about 10% of leases are not being correctly applied. When discrepancies occur the determining valuer should go back to the parties to resolve the difference. Without this communication it remains possible that a determination reflecting the lease is not fairly applied to one party or alternately the error is later found and rectified and yet the determination is based on incorrect data. The Valuation Calculation Definition ‘Market Rental Value’ is the estimated amount for which an asset should rent, as at the relevant date, between a willing lessor and a willing lessee in an arms’ length transaction, wherein the parties had each acted knowledgeably, prudently and without compulsion, and having regard to the usual terms and conditions for leases of similar assets. In making a determination of a current market rent, the specialist retail valuer must determine the rent on the basis of the rent that would reasonably be expected to be paid for the retail shop if it were unoccupied and offered for lease for the use for which the shop may be used under the lease or a substantially similar use. The determination of the rental is to be on an effective rent basis and is to be a gross rent less lessor’s outgoings payable by the lessee. Two Step Process There is a two step process to determine market rental. Step 1 is to determine the market rental having regard to usual terms and conditions of the market. Step 2 is to then making whatever adjustments as are necessary to reflect the subject lease terms and conditions. Where the subject lease reflects the “usual terms and conditions of the market” Step 2 requires no adjustment however, the inherent logic should be considered by the determining valuer. If there are differences between the normal terms and conditions evident in the market and the terms and conditions in the lease of the subject property, which are not taken into account, it is possible the determination is flawed, albeit still final and binding in accordance with Section 33. Units of Measurement There is a wide range of units of measurement that could be used in a determination. Whilst each has to be appropriate you may also find more than one method has been used. Retail may be assessed as $ per linear measure of frontage which is very applicable in strip shops and I find foodcourts; $ per square metre; $ per annum as percentage of expected turnover of the “average competent operator”. Each may be relevant for the particular assessment or a combination may be appropriate. Process of Valuation – Report My goal in preparing a determination report is of course to come out with a determination and to put the logic of that determination in writing to the parties. The determination should however have some regard for the parties. They have been in a dispute and need to live together into the future. ../7 -7- The determining valuer should give sufficient explanation for the parties to understand the logic even though they still may disagree with the final conclusion. This is particularly the case with retail businesses. You want the tenant to be able to go back and concentrate on the business and not focus on the valuation. To this end I believe a report should be structured in the following manner: 1. Identify which version of the Retail Shop Leases Act is the version that was in existence at the commencement of the lease. It is that Act that the lease minimum standards clauses apply to; 2. Set out the lease epitome identifying the critical aspects of the lease, particularly those that relate to market rental; 3. The major part of the report, however, is dedicated to submissions by the parties. I like to identify each submission from the parties and provide my comments whether I agree or disagree with that submission. The parties to the lease may not like the decision that is made, but they should at least know the decision made in respect to each aspect of their concerns and that they have each been considered; 4. Detail as far as confidentiality permits, independent research and more importantly the determining valuer’s own analysis on each of the matters that should be taken into consideration in assessing the property, including consideration to all the benefits and detriments. 5. Set out the determination. Submissions to Determining Valuer – Make the Job Easier Lead the Valuer to the Desired Conclusion The simple fact is if you want the determination to come out in your client’s favour you must put a submission to the valuer that is going to achieve that. Most submissions I receive seem to concentrate on actions by the other party that are contrary to the lease. There are emotive matters that may annoy the parties but are totally irrelevant when it comes to a rental determination. The parties to the lease often know a lot about the market, albeit this is often in non-specific terms. The submission to the valuer can provide this non-specific evidence to be followed up by the determining valuer or preferably provide fully researched evidence from which can be made a logical conclusion which supports the desired outcome. The parties to the lease are in dispute because of something they believe. Don’t leave the determining valuer guessing in the hope that he/she might by chance arrive at the same conclusion. Spell it out – make it easy for the determining valuer to reach your client’s desired conclusion. Last month I completed a determination on a business that operated around 20 similar businesses in south east Queensland. The tenant’s comment when I asked him for specific evidence was “But isn’t that your job – to do the research and come up with a determination”. Certainly the answer is “yes” but that was what I was doing. It was like drawing hens’ teeth but I finally was given evidence of actual rental and outgoings and weekly turnover for the past 15 months on each of the comparables. The evidence that he was reluctant to provide was quite definitive and it became clear why the tenant thought the rental was too high. A determination, whilst normally completed as an expert, is in reality similar to arbitration or for that matter any court case. Why should the “expert determination” of a rental be given any less attention. The only difference is the “expert determining valuer” is free if he/she deems necessary to make further enquiries ../8 -8- Submission v Valuation When making a submission, even though the conclusions may be the same in dollar terms, I will not call it a valuation. I have seen many advocate submissions drafted in the form of valuations by people who should know better, particularly when the conclusion is not supported by the evidence presented. The expert will identify a logical approach and present compelling arguments as to why the determining valuer should adopt that logic and conclusion. I believe it is part of my job when preparing a submission to educate my own client. I do not put under my hand my client’s opinion. The valid argument will lead the determining valuer to maximise your client’s position. The client’s opinion presented under the hand of a valuer is usually obvious to the determining valuer and is likely to be rejected. Allen J Crawford F.R.I.C.S F.A.P.I.