A promising shopfront, office or warehouse can lose its appeal quickly when the lease terms arrive late, change without warning, or leave major costs unclear. Commercial lease heads of agreement give landlords and tenants a chance to settle the commercial deal before investing time and legal costs in a full lease. They are useful, but they need to be treated seriously from the outset.

What are commercial lease heads of agreement?

Heads of agreement, sometimes called a heads of terms or lease proposal, is a document recording the principal terms agreed between a prospective landlord and tenant. It commonly comes before the formal lease is prepared and signed.

For a tenant, it is the point at which the apparent weekly or monthly rent becomes a complete business commitment. For a landlord, it is where the income, risk allocation and control of the premises begin to take shape. Getting these matters right early can avoid expensive negotiation once solicitors are working from a draft lease.

A heads of agreement is not automatically non-binding simply because it has that label. Whether it creates legal obligations depends on its wording, the parties’ conduct and the terms agreed. Some documents state that the commercial terms are subject to a formal lease being negotiated and executed. Others make particular obligations binding, such as confidentiality, exclusivity, payment of a deposit, access for due diligence or responsibility for legal costs.

That distinction matters. Do not sign on the assumption that a document is only an informal indication of interest. Read the binding clause, the conditions and the execution block carefully before committing.

The terms that should be agreed before the lease is drafted

The more clearly the heads deal with the key issues, the less room there is for an unwelcome surprise in the formal lease. A short document can still be commercially complete. At a minimum, it should accurately identify the premises, including any storage areas, car spaces, loading zones and shared facilities the tenant expects to use.

The agreed rent must say whether it is expressed as a net, gross or face rent, whether GST is additional, when it is payable and how it will increase. Fixed percentage reviews, CPI reviews and market reviews can produce very different results over a five or ten-year term. If a rent-free period, fit-out contribution or other incentive is offered, record its amount, timing, conditions and any clawback if the lease ends early.

The initial term, commencement date and any option periods need equal attention. A tenant may need a conditional commencement date where fit-out approvals, finance, a liquor licence or development consent are still pending. An option is only valuable if its notice period, rent-setting method and conditions are realistic. Missing an option deadline by a day can have serious consequences.

A useful heads of agreement will usually address the following matters:

• the premises, permitted use and any exclusivity rights;
• rent, GST, outgoings, rent reviews and incentives;
• lease term, options, commencement conditions and access before commencement;
• security, whether by bank guarantee, cash bond or personal guarantee;
• fit-out works, approvals, contribution arrangements and ownership of improvements;
• repair, maintenance, insurance and make-good obligations; and
• assignment, subleasing, demolition, relocation and early termination rights.

These points are interconnected. For example, a lower starting rent may look attractive, but not if the tenant also carries broad outgoings, substantial make-good works and an uncapped obligation to repair ageing air-conditioning equipment. The commercial deal should be assessed as a whole.

Permitted use and approvals

The permitted use should be specific enough to protect the tenant’s intended business, but not so narrow that ordinary changes to products or services require landlord consent. A café, for instance, may need the right to provide dine-in, takeaway, catering and online delivery services. A professional services business may want flexibility to offer related services as it grows.

The proposed use must also work under planning controls, any development consent, building classification, strata by-laws and centre rules. A landlord’s agreement to lease premises for a particular purpose does not necessarily mean the use is lawful or that approvals will be obtained. Where approvals are uncertain, the heads should state who is responsible for pursuing them, who pays, and what happens if they are refused or delayed.

Outgoings and operating costs

Outgoings are often where a lease becomes more expensive than expected. In a commercial lease, they may include council rates, water rates, land tax where permitted, strata levies, insurance, management charges and maintenance costs. The heads should say which outgoings are recoverable, whether estimates have been provided, and whether there are exclusions or limits.

Tenants should ask for a clear breakdown rather than accept a broad reference to “all outgoings”. Landlords should ensure the description reflects the intended cost recovery model and the particular property. Retail leasing has additional disclosure and statutory requirements in New South Wales, so the position should not be copied blindly from a non-retail lease.

Fit-out, condition and make-good

Fit-out negotiations need more detail than a promise that the premises will be handed over “as is”. Record the condition in which the premises will be delivered, any landlord works, the tenant’s proposed works, approval processes, contribution payments and access dates. If specialist equipment, exhaust systems, signage or services upgrades are required, confirm whether the building can accommodate them.

Make-good is the other side of the fit-out discussion. A tenant may be required to remove its fit-out, reinstate the premises to a base-building condition, repair damage and return keys, access devices and documents. That can be costly at the end of a lease. The heads should establish whether make-good is required and, where possible, define the expected standard before the tenant spends money on works.

NSW issues that should not be left to the last minute

In New South Wales, the Retail Leases Act 1994 may apply where the premises and business fall within the retail leasing regime. Its application depends on the circumstances, including the type of premises, use and any exclusion. If it applies, disclosure obligations, limits on certain costs and processes for retail lease dealings can affect the agreement.

A prospective tenant should receive the proposed lease and relevant disclosure material early enough to understand the commitment. The disclosure statement is not a substitute for reading the lease, but it can expose issues that deserve questions, such as estimated outgoings, planned works, trading-hour requirements or relocation and demolition provisions.

For commercial and retail premises alike, title, zoning and property-specific constraints should be checked. Is the landlord entitled to grant the lease? Does a mortgagee consent need to be obtained? Is there a strata scheme, heritage control, flood issue or council approval that affects the intended use? A heads of agreement can include due diligence conditions where these matters are not yet known.

Security is another area where business owners should look beyond the headline amount. A personal guarantee can expose directors or business owners personally if the company tenant defaults. A bank guarantee may remain callable until all obligations, including make-good, have been met. The amount, release conditions and replacement requirements should be negotiated with the same care as rent.

When to obtain legal advice

Legal advice is most valuable before the heads are signed, not after the commercial terms have hardened. At that stage, changes can usually be discussed without the cost and friction of redrafting a lengthy lease. It also gives both parties a clearer path to a document that reflects the deal they actually intended.

For tenants, early advice can identify costs, restrictions and personal exposure that may affect whether the premises are viable. For landlords, it can help ensure the proposal protects the property, supports reliable rent recovery and does not promise concessions that cannot be delivered.

GKE Lawyers can review proposed lease terms with a practical focus on the NSW property, planning and commercial issues that may affect your decision. A well-prepared heads of agreement will not remove every future negotiation, but it gives that negotiation a firm, clear starting point and helps both parties move forward with fewer surprises.