When establishing a new charity or not-for-profit entity, a fundamental decision that must be made early on will likely be: “should my charity purchase or lease its premises?”. Whilst the purchase of land and buildings may be attractive to some charitable and not-for-profit entities due to the benefits of having legal ownership over the property, many of these entities still choose to enter into leasing arrangements. This leads to the obvious question:
Why might a charity seek to enter into a lease?
There are many advantages for charities choosing to lease property rather than purchase:
- Flexibility – leasing a property provides a level of flexibility to a charity, allowing for adaptability should the charity experience exponential growth or a change in operations which requires a different property more suited to its new operations. Additionally, where the lease is for commercial property, the charity may wish to trial providing its services from a particular location on a short-term lease – rather than making a long-term commitment to that location through a purchase.
- Financial Benefits – the rates of rent and rental increases may be more sustainable and affordable than those offered under a mortgage for a contract of sale. Leasing arrangements may be especially attractive to charities which have just commenced operations, as a leasing arrangement may free up additional capital which can be put towards establishing the charity’s operations and income streams – capital which would otherwise have been spent on paying the purchase price under a Contract of Sale.
- Taxation benefits – state land tax, local council rates and other forms of taxation are generally charged to the person who is the registered owner of the property (rather than the occupier of the property). Leasing arrangements can be tailored to allow for creativity and flexibility in how these costs are divided between the Landlord and the charity (if the charity pays these costs at all!).
- Compliance Reasons – typically charitable entities forming part of the same corporate group will seek to put in place formal leases between the different group members to clarify ongoing obligations and apportion liabilities across the entities. It is also useful for providing documentary evidence of market value and market terms where required by the ACNC for related party transactions reasons.
What should my charity turn its mind to before entering into a lease?
There are numerous factors that charities should consider in deciding whether to enter into a lease agreement:
- Jurisdiction – by what state’s/territory’s legislation is the lease governed? Leases for real property are generally governed by state-based legislation – each with their own nuances and requirements. Seek legal advice to ensure that the charity is fully across its relevant state’s/territory’s requirements.
- Leased Premises – is the lease drawn up for the actual land or building (or part thereof) that the charity is seeking to lease, or is it for some other property/building? Is it a residential or commercial premises?
- Retail Shop Leases – if the lease is categorised as a Retail Shop Lease, then there may be additional disclosures/documents that the charity must provide to the Landlord and minimum standards alternative to those of standard commercial leases as provided by the state’s Retail Shop Lease legislation.
- Lessor/Landlord – who is the Landlord? Are they related to the charity? Where the Landlord is a related party to the charity, additional care should be taken to ensure that the transaction is on market terms (or terms more favourable to the charity) and that the parties are dealing with each other “at arm’s length”. This is especially important for non-state (independent) schools and charitable entities related to such schools, since a failure to transact at arm’s length when entering into a lease may amount to “prohibited transaction” and put the school’s accreditation at risk.
- Term and Options – when does the lease commence, and when will it expire? The charity should consider whether the term is too short / too long for its purposes, and whether the charity will have any options to extend the lease (as well as how the lease requires those options to be exercised).
- Rent and Outgoings – is the rent and outgoings amounts on market terms? How is rent calculated (base rent; base rent plus turnover rent; turnover rent only)? Who is responsible for the payment of outgoings (e.g. electricity, gas, air conditioning, water)? Are outgoings included in the rent, or will they be paid separately? How will outgoings be calculated (by usage; by a flat fee contribution)? A charity should consider these questions to avoid being locked into a lease with undesirable terms.
- Rent Reviews – Does the rent increase at a fixed rate or with CPI? How many rent reviews will occur per year? A charity should consider whether it will be able to afford regular rent payments and rent increases during the term of the lease. Allowing a charity to pay excessive amounts of rent may also detract from the charity’s ability to pursue its charitable objectives, and could attract unwanted scrutiny from the Australian Charities and Not-for-profits Commission (for ACNC-registered charities).
- Security – how will the charity guarantee the performance of its obligations under the lease? Is a security deposit payable, or will a bank guarantee or personal guarantee be provided?
- Permitted Use and Exclusive Use – For what purposes does the lease allow the charity to use the leased property? Have the appropriate searches been performed to ensure that the permitted use is lawful under local council and zoning laws? Congruency between the Permitted Use and the charity’s charitable objectives is crucial in ensuring that the charity will not be unnecessarily restricted in pursuing its objectives.
A charity should also consider advocating for lease term which provides for exclusivity of use – prohibiting the Landlord from leasing another part of its premises, within a certain distance from the leased premises, to an organisation which is similar in nature to the charity.
- Privacy – what rights will the charity tenant have to quiet enjoyment of the leased premises? What rights does the Landlord have to access and inspect the leased premises, and will these impact on the charity’s operations?
- Improvements and Fit-out – can the charity make renovations to the leased property to make it more fit for the charity’s purposes? If the charity improves the value of the premises through fit-outs and renovations, who owns the value of those improvements?
- Tenant’s Access Rights – how will the charity access the property? Is access encumbered by the current state of the property or happenings occurring around the property boundaries?
- Prior Encumbrances – is the premises the subject of the lease already leased to another person? A charity should make sure that it is not seeking to lease a property already in the possession of another.
- Landlord’s Rights of Sale – a clause is typically inserted into a lease requiring that if the Landlord sells the leased premises to a Buyer then that Buyer takes ownership subject to the charity’s lease. This clause aims to protect the charity’s tenure under the lease.
- Assignment / Sub-letting – does the charity have any rights to sublease or assign its rights/obligations under the lease to a third party during the lease term? Is the Landlord required to approve such arrangements?
- Insurances, Maintenance and Damage to Property – who is responsible for rectifying damage to a property and ensuring the property is maintained to an appropriate standard? Will the charity be required to revert the property to its original condition at the end of the lease? Who bears the costs of taking out insurances over the property?
- Termination Rights – What actions (of the Landlord or the Tenant) warrant a terminable breach of the lease? Termination rights under the lease must be considered carefully so that the charity does not overstep its rights and obligations and inadvertently give the Landlord the right to terminate the lease.
- Legal Advice – a charity should thoroughly consider obtaining legal advice as to the terms and conditions of any proposed lease into which it is considering entering. For some leases (such as Retail Shop Leases under the Retail Shop Leases Act 1994 (Qld)) a charity may be required to obtain a legal advice certificate as part of the lease execution process.
If your charity or not-for-profit is considering entering into a lease, consider letting the experienced Commercial Team at Vocare Law assist you. Our team can provide you with tailored advice as to the terms and conditions of the proposed lease, so that you can be confident that the proposed lease is fit for your charity’s or not-for-profit’s purposes.
Contact our commercial team today on 1300 862 529, or send us your enquiry here.
This article was written by Jackson Litzow & Simon Mason.
The information contained herein does not, and is not intended to, constitute legal advice and is for general informational purposes only.
