Market rent review vs fixed or CPI: which suits tenants best

Most retail leases in Victoria include a rent review clause that determines how your base rent will change during the term. The three common methods are fixed increases, adjustments linked to the Consumer Price Index (CPI), and market rent reviews. Each method has different implications for your cash flow, risk and negotiating leverage. The best choice depends on your business model, lease length and market conditions.

How each rent review method works

Fixed increases are the simplest. The lease specifies a percentage or dollar amount by which the rent will rise each year. For example, the lease might say “rent increases by 3% on each anniversary”. The increase is known in advance and does not change, regardless of inflation or market conditions.

CPI adjustments link the rent increase to the percentage change in the Consumer Price Index, usually the Melbourne or Australian all-groups index. The lease will specify which quarter’s CPI is used and whether there is a cap or collar on the adjustment. If CPI rises by 2.5%, the rent rises by 2.5%.

Market rent reviews reset the rent to the current market level for comparable premises. The lease will define how “market rent” is determined, often by reference to recent leases in the same centre or strip. If the market has softened, the rent can go down; if it has strengthened, the rent can rise sharply.

Predictability and cash flow planning

Fixed increases give tenants the most certainty. You know exactly what your rent will be for the entire lease term, which makes budgeting straightforward. This is especially useful for businesses with tight margins or seasonal cash flow, such as cafes or fashion retailers. The downside is that if inflation is higher than the fixed increase, your rent becomes relatively cheaper for the landlord over time.

CPI adjustments are less predictable than fixed increases but more predictable than market reviews. You can estimate the likely increase using the Reserve Bank’s inflation forecasts, but the actual figure won’t be known until the relevant CPI data is released. For tenants, CPI adjustments can feel fairer than fixed increases because they track general price movements rather than an arbitrary percentage.

Market rent reviews are the least predictable. The outcome depends on current market conditions, which can be influenced by factors outside your control, such as new developments, anchor tenant closures or economic downturns. For tenants, this unpredictability can make long-term planning difficult, particularly if the lease includes multiple market reviews.

Fairness and alignment with market conditions

Fixed increases can work in your favour if the market weakens, but they can also lock you into above-market rent if the market strengthens. For example, if you sign a five-year lease with 3% fixed increases and the market softens in year three, you could end up paying more than the current market rent. Conversely, if the market booms, your rent will be below market, which is a win for you.

CPI adjustments are designed to keep rent in line with general price movements, not the specific retail market. This means your rent could still be above or below market, depending on how retail rents are trending. For example, if retail rents in your area are falling but CPI is rising, a CPI-linked increase could leave you paying more than the market rate.

Market rent reviews are the only method that directly ties your rent to the current retail market. If the market has fallen, your rent can decrease, which is a rare but valuable outcome for tenants. However, if the market has risen, your rent can increase significantly, sometimes by more than CPI or a typical fixed increase. The Retail Leases Act 2003 (Vic) requires landlords to provide evidence of comparable rents if you dispute a market review determination, which gives you some protection against unfair outcomes.

Negotiating leverage and lease length

Your choice of rent review method can affect your negotiating position when the lease is up for renewal or assignment. Fixed increases can work against you if the market has softened, as the landlord may see an opportunity to reset the rent to a higher market level at renewal. Conversely, if the market has strengthened, a fixed increase can work in your favour, as the landlord may be reluctant to lose a tenant paying below-market rent.

CPI adjustments can reduce the landlord’s incentive to push for a market review at renewal, as the rent is already tracking general price movements. This can make renewals smoother and less contentious, particularly in stable markets. However, if retail rents are falling faster than CPI, the landlord may still push for a market review to capture a higher rent.

Market rent reviews are most common in longer leases, typically five years or more, where the landlord wants to ensure the rent keeps pace with the market. For tenants, the key is to negotiate clear, objective criteria for determining market rent, such as a defined pool of comparable premises and a requirement for the landlord to provide evidence of recent leases. Without these safeguards, market reviews can become a source of dispute.

Key negotiating points for market rent reviews

• Comparable premises: Define what counts as a comparable premise. Ideally, this should be limited to similar-sized shops in the same centre or strip, with similar frontage, exposure and tenant mix.
• Evidence requirement: Insist that the landlord provides written evidence of recent leases for comparable premises, including the rent, lease term and any incentives. The Retail Leases Act 2003 (Vic) requires this if you dispute the determination.
• Independent valuer: If you and the landlord cannot agree on the market rent, the lease should specify that an independent valuer will determine it. The valuer’s fees are usually split equally between the parties.
• Cap on increases: Consider negotiating a cap on the percentage increase that can result from a market review. This can limit your downside risk if the market has risen sharply.
• Frequency: Avoid market reviews more frequently than every three years, as they add uncertainty and can disrupt your business planning.

Cost-effectiveness over the lease term

To compare the long-term cost of each method, you need to consider how each one interacts with market conditions. Fixed increases are the most cost-effective if the market weakens, as your rent will be lower than the market rate. However, if the market strengthens, fixed increases can become expensive, as you’ll be paying below-market rent until the next review or renewal.

CPI adjustments are generally more cost-effective than fixed increases in high-inflation environments, as the rent rises in line with general prices. However, if retail rents are falling, CPI adjustments can leave you paying more than the market rate. In low-inflation environments, CPI adjustments may result in smaller increases than fixed percentages, which can be an advantage for tenants.

Market rent reviews are the most cost-effective if the market weakens, as your rent can decrease. However, if the market strengthens, market reviews can result in sharp rent increases, which can be difficult to absorb. The key is to negotiate safeguards, such as caps on increases and clear criteria for determining market rent, to limit your downside risk.

Which method is best for your business?

There is no one-size-fits-all answer. The best rent review method depends on your business model, lease length and risk tolerance. For short leases (three years or less), fixed increases or CPI adjustments are usually preferable, as they provide predictability and reduce the risk of a sharp rent increase. For longer leases, market rent reviews can be a good option if you negotiate safeguards to limit your downside risk.

If your business has stable cash flow and you can absorb some uncertainty, market rent reviews may be worth considering, as they can result in rent decreases if the market weakens. However, if your margins are tight or your cash flow is seasonal, fixed increases or CPI adjustments are usually the safer choice.

Before signing a lease, ask your leasing consultant to model the likely rent outcomes under each method, using different scenarios for inflation and market conditions. This will help you understand the trade-offs and choose the method that best suits your business.

Frequently asked questions

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Elite Retail Leasing acts for retail tenants across Australia on new sites, renewals, lease negotiations, surrenders and expansion planning. If any of the above applies to your business, get in touch.

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