Does your old lease still have the word “fair” as a description of market rent? Many occupiers (tenants) and landlords of commercial real estate have a misconception of the meaning and usage of the term fair market rent.
Let’s remove the word “fair” for the time being and review Market Rent. This term is often used in commercial leases within the context of providing tenants with options to renew or extend their lease. An important element of this option clause is the determination of the rent payable for the renewal term. One method used to establish the renewal rental rate is to determine (fair) “market rent” for the subject premises. For comparative purposes, other methods to determine renewal rent may be: a fixed rate, prescribed escalations or the use of CPI to name a few.
So let’s stick with the (fair) market rent approach. What is it supposed to mean in academic terms? A generally accepted definition of (fair) market rent has six components:
- rent that would reasonably be obtained by a willing landlord,
- for similar premises,
- from a willing tenant dealing at arm’s length,
- in the prevailing market,
- for a term commencing on the relevant date, and,
- having regard to all relevant circumstances (i.e. duration of term)
As you can see, the word “fair” doesn’t form part of the definition. It’s likely that “fair” was intended to describe the process, maybe. The concept of fair market rent is typically used by the landlord and tenant based on the assumption that it provides a mutually acceptable approach for determining an equitable renewal rental rate.
Now let’s be practical. The idea that the concept of fair market rent resulting in mutually beneficial negotiations is weak at best: a landlord and tenant are pursuing divergent results. Landlords search for ways to achieve the greatest possible rent, while tenants attempt to reduce or at least maintain their current rental rate.
If you have a lease that still includes the word “fair” you should remind the landlord of its intended meaning. The best advice in trying to understand (fair) market rent is to break-down and tackle each of the three words, fair – market – rent. The three words should never appear to together in a lease (renewal clause) let alone in negotiations, unless individually defined and fully understood by all parties during the original lease negotiations.
Have a read of the other sections of What You Should Know to help you with the application of (fair) market rent.