What is the condition of your Schedule of Condition?
With the recent downturn in commercial property activity now is not a time to lose sight of good property management, especially in relation to the Schedule of Condition in the terms of your lease.
A crucial component of a good leasing strategy understands the importance and purpose of a Schedule of Condition. All too often Make Good negotiations are made more complicated and protracted, not to mention more expensive, because there is no record of the condition of the premises at lease commencement.
Whilst the general purpose of a Schedule of Condition is acknowledged in the market place, their value as an effective tool in preventing disputes and removing ambiguity during the negotiation process is less understood and appreciated.
The level of protection a Schedule of Condition provides depends on a number of factors, namely the accuracy and detail of the schedule, the length of the lease and the lease obligations. At worst a poorly prepared Schedule will offer little or no protection to the tenant if it fails to properly record the property’s condition in the context of the lease obligations, is too ambiguous or, simply, is improperly or poorly referenced to the lease.
Recently N&B were instructed by a tenant of a large dilapidated warehouse after they were served with a Final Schedule of Make Good totalling more than $1,000,000.
The lease term was for 5 years and did not have the protection of a Schedule of Condition. Constructed in the early 1970’s, poorly maintained for longer than the preceding 5 years, the yield up clause in the lease required the tenant to deliver the property to the landlord in the condition which the lease stated as being “Good”, which would certainly have not been the case.
Fortunately for our client, we were able to reduce the claim to circa $200,000. If a Schedule of Condition was prepared at lease commencement, however, the agreed settlement would have been negligible.
Make Good Makes the Difference
Whether you are a landlord or tenant, prior to signing a lease, during a lease or at lease end, accurate and timely Make Good advice can potentially save you a considerable amount of money and anxiety.
Steve Di Leo, Principal of WHK Horwath, one of the largest accounting groups in Australia, agrees and says of their clients “Corporates with the best Leasing Strategy make sure they understand how their Make Good component affects their bottom line” and sound Make Good agreements can significantly affect not only the Tax, but also the financial health of the signatories.
Now, more than ever, landlords and tenants need to make sure that they fully understand the commitments in their Make Good agreements to ensure “that they don’t find themselves in a situation where they have spent a million dollars on a fit out only to find that they’re not eligible to receive the best tax outcomes they may have hoped for.” Di Leo advises. While many larger corporates may have the Tax component under control, they may not have made provision for the new International Financial Reporting Standards (IFRS) accounting standards nor understand that a Future Make Good Obligation is an actual liability and not a contingent liability.
For example, if the estimated cost of your Future Make Good Liability at the end of your lease is $60,000 and the lease term is 5 years, then this appears as a $1,000 expense item on your monthly Profit & Loss and a $12,000 expense item on your annual P&L.
IFRS dictates that each year this estimated liability must be reviewed and updated to ensure continuing accuracy. This review should take into account market price fluctuations and any additions or reductions to your liability due to any works that may have taken place during the preceding year.
Further, a well managed Make Good that accounts for tenant departure and temporary vacancies can benefit landlords with Reversionary Depreciation rights that may accrue to them when a tenant departs. An example of this would be if a tenant incurred $20,000 on a fit out in 2000 and left the premises in 2005, they would have claimed a total of $2,500 in 5 years. After the lease terminates, the construction expenditure pool of $17,500 would revert to the landlord affording them a additional $500pa claim on building allowance, assuming there is new tenancy.
So the advice from Di Leo and WHK Horwath is “to make sure that, when you enter into lease arrangements, you are clear of the Tax and Accounting implications of the agreement because it’s not something you need to think about at the end of your lease, it’s got ongoing implications now for both landlords and tenants.”
