Commercial Lease Analysis for Property Buyers

A commercial property can look attractive on a listing sheet and still carry a weak income stream. Commercial lease analysis tests the contract behind the advertised yield: who pays the rent, how long they are committed, what costs sit with the owner, and what happens if the tenant leaves. For a buyer inspecting from Sydney or Melbourne, those questions cannot be answered by photos, a rent schedule and an agent’s commentary.

The lease is not a secondary document. For many small to mid-size commercial assets, it is a major part of the investment case. The building may be in a sound location, but a poorly structured lease can reduce income, create an unexpected vacancy period or leave the purchaser responsible for costs they assumed were recoverable.

Start commercial lease analysis with the actual income

First, separate the advertised figure from the income the owner receives after property costs. Yield is the annual income from a property expressed as a percentage of its purchase price. A net yield generally refers to income after the recoverable and non-recoverable ownership costs are considered. The label matters, because agents do not always use the same definition.

Consider a small industrial unit in Eagle Farm offered at $2 million with rent of $120,000 per year. The simple passing yield is 6 per cent. Passing rent means the rent currently paid under the lease. If the owner also pays $14,000 each year in land tax, management, insurance shortfalls and unrecovered maintenance, the income position is materially different from the headline number.

Request a detailed rent schedule and reconcile it to the lease, recent rent receipts and the most recent outgoings reconciliation. Check the base rent, GST treatment, incentives, car park income, storage income and any arrears. A rent-free period or landlord contribution agreed when the tenant renewed may not be obvious in the advertised rent.

The key question is simple: what cash income is contractually due, what has actually been collected, and which costs remain with the owner?

Read the lease term before relying on WALE

WALE means weighted average lease expiry. It measures the average remaining lease term across a property, weighted by each tenant’s share of rent. A single-tenant asset has a straightforward WALE: if the lease ends in 2.5 years, the WALE is 2.5 years.

A longer WALE usually gives more income visibility, but it is not automatically better. A seven-year lease to a business under financial pressure may present more risk than a three-year lease to an established tenant with strong turnover, a suitable premises and a demonstrated reason to stay.

Read the original lease, every variation, option notice, incentive deed and assignment document. A lease summary is useful, but it is not enough for a purchase decision. The documents should establish:

• the lease commencement and expiry dates;

• renewal options, including the date and method for exercising them;

• rent review dates and the review mechanism;

• permitted use, assignment rights and subleasing rights; and

• make-good obligations when the tenant leaves.

Options need particular care. A five-year lease with one five-year option is not the same as a secured ten-year income stream. The tenant may choose not to exercise the option, particularly if market rent is lower than their current rent, the premises no longer suit their operation, or relocation is practical.

Rent reviews should also be modelled rather than accepted at face value. Fixed annual increases of 3.5 per cent provide certainty but may move rent above local market levels over time. CPI reviews follow inflation, which can fluctuate. Market reviews may include a ratchet clause, meaning rent cannot fall at review, but the enforceability and effect of such clauses depends on the lease wording and circumstances. A solicitor should review the legal operation of the lease. The buyer should still test the commercial outcome.

Test the tenant’s ability and incentive to remain

Tenant quality is more than a recognisable trading name. The tenant named on the lease may be a small operating company with limited assets, even where the business trades under a familiar brand. Identify the legal tenant, any guarantor, and whether a director has provided a personal guarantee. Then assess the evidence available on their capacity to meet rent.

For a retail shop in a neighbourhood centre, trading performance and foot traffic may matter most. For an industrial tenant in Acacia Ridge or Rocklea, the practical value of hardstand, access for rigid trucks, power supply, clearance height and proximity to freight routes may make the premises difficult to replace. For an office tenant in Milton, the fit-out, parking allocation and staff access to rail can influence retention.

Ask for evidence, not assurances. This may include payment history, rent arrears reports, correspondence about lease renewal, public company information where available, and confirmation of any disputes. The seller may be unable to provide every item due to confidentiality. That limitation should be documented and reflected in the risk assessment rather than ignored.

The tenant’s business fit is equally relevant. A physiotherapy clinic with purpose-built treatment rooms may face meaningful relocation costs. A generic professional office tenant in a building with high vacancy may have many alternatives. The second tenant may require a more conservative vacancy allowance at lease expiry.

Check who pays the outgoings

Outgoings are the costs of holding and operating the property. They can include council rates, water charges, building insurance, land tax, strata levies, management fees, cleaning, security, repairs and maintenance. Whether they are recoverable from the tenant depends on the lease and, for retail property, applicable legislation.

Do not assume a lease described as net leaves the buyer with no costs. A tenant may reimburse ordinary outgoings but not capital works, structural repairs, major plant replacement, leasing costs or land tax above a stated threshold. In a strata office, sinking fund levies may be payable by the owner even when routine levies are recovered.

Compare at least two years of actual outgoings with the current budget. A sudden increase in insurance premiums, body corporate levies or maintenance can change the net income. For example, an ageing air-conditioning system in a Fortitude Valley office suite may work at settlement but still require replacement before the next lease event. The lease may not allow that cost to be recovered.

Match the lease to the property and planning controls

A lease can only support the intended use if the property can lawfully accommodate it. Review the current use, approvals and zoning. Planning overlays are mapped planning controls that add requirements or constraints to land, such as flood, heritage, character, biodiversity or airport noise considerations.

In Brisbane, flood overlay mapping can affect insurance, future alterations and a tenant’s willingness to remain after a major weather event. In industrial precincts, confirm that truck movements, storage, trade activity and operating hours align with the site’s approvals. For mixed-use property, also identify whether residential occupants may constrain noise, deliveries or trading hours.

This is not a theoretical exercise. A tenant may have operated from a site for years under arrangements that do not neatly match current approvals. That does not necessarily stop a purchase, but it changes the due diligence task. Obtain planning advice where the use, approval history or proposed future use is unclear.

Model the lease expiry, not just the purchase date

A sound commercial lease analysis includes a downside case. Estimate the likely period without rent if the tenant leaves, the cost to re-lease, incentives required for a new tenant, and the market rent that could reasonably be achieved. This is not a price prediction. It is a test of whether the asset remains acceptable if the current lease does not continue.

For a 180-square-metre industrial unit, a six-month vacancy, $20,000 of leasing costs and a $15,000 make-good shortfall can absorb a substantial part of several years’ income. A buyer should know that exposure before exchange, not when the tenant gives notice.

Compare the passing rent with current asking and achieved rents for similar premises. Asking rents are useful indicators, but signed lease evidence carries more weight where it is available. Also consider supply. A wave of new strata units in a nearby precinct may give tenants more choice at renewal, even if the current tenant is reliable.

Build an audit trail before making the offer

The practical output should be a short lease risk register, not a stack of unranked documents. Record the lease expiry, options, review dates, passing rent, estimated net income, unrecovered outgoings, tenant evidence, approval issues and the main downside assumptions. Mark each item as confirmed, unconfirmed or requiring specialist advice.

That record makes negotiations more disciplined. If expiry is close, rent is above local evidence or the roof liability is unclear, the buyer can seek further information, negotiate a condition or adjust the offer to reflect the risk. Sometimes the appropriate decision is to proceed. Sometimes it is to wait for better evidence. The value is in making the trade-off visible.

A commercial lease is a live operating agreement, not a figure copied into a brochure. Read it closely, test it against the property and local market, and keep a clear record of what the evidence does and does not support. That gives the buyer a sounder basis for the decision they must live with after settlement.