Why this matters. Two commercial deals with identical 6.5% headline cap rate can produce a $200k+ difference in 10-year net income depending on the review clause structure. The lease review mechanism is the most important line item in the contract and the one investors skim in DD.
The four review mechanisms
| Mechanism | How it works | Landlord risk |
|---|---|---|
| Fixed % | Set percentage annual increase (typically 3-4%). Compounds. | Low. Predictable. Deflation risk (rare in AU). |
| CPI | Tied to Consumer Price Index quarterly release. Uncapped or capped. | Medium. Follows inflation reality but can be volatile. |
| Market review | Rent reset to prevailing market rent at review date. Independent valuer. | High. Rent can go up, down, or nowhere. Requires market context. |
| Hybrid | e.g. Fixed 3.5%/yr with market review at year 5 option renewal. | Medium. Balances predictability with market alignment. |
Ratchet vs non-ratchet
This is the killer clause. Applies to CPI and market review mechanisms.
- Ratchet (up-only): rent can rise at review but cannot fall below the current rent. Deflation-proof for landlord.
- Non-ratchet: rent floats to whatever CPI or market review determines. Can go down.
In a well-drafted commercial lease favouring the landlord, every CPI/market review clause is ratcheted. In a lease favouring the tenant, it isn't. This one word in the contract, "ratchet," changes the risk profile of the investment materially.
What to look for in DD. When reviewing a commercial lease, search for the review clause. Ask specifically: "Is this a ratchet review?" If your solicitor says "no" or "the clause isn't clear," negotiate the change or reduce your offer to compensate. Non-ratchet CPI in a low-inflation environment can produce zero or negative rent growth.
The value math
Two identical $650k retail strips, both with 7% starting net yield, both with 5-year initial leases + 2 × 5-year options. Difference: review mechanism.
Deal A: Fixed 4% annual + market review at option
Deal B: CPI review + non-ratchet
Difference: $41,100 over 10 years. Same headline yield at contract exchange. Meaningfully different actual returns. And that's before considering the capital value impact at sale (a property with predictable 4% escalation sells at a lower cap rate than one with uncertain CPI).
What each mechanism means for you
Fixed % (most landlord-friendly)
You lock in predictable compound growth. 3.5-4% is typical for good commercial leases. In a 3% inflation environment, you're 0.5-1% ahead. In a 5% inflation environment, you're falling behind but still growing in absolute terms.
Best for: Predictable-cash-flow investors, SMSF investments, retirement income planning.
CPI (inflation-matched)
Your rent tracks the actual cost of living. In high inflation you win. In low inflation you match. Non-ratchet CPI in a deflationary period is bad but rare in Australia.
Best for: Investors who want inflation hedge but are willing to accept lower certainty. Preferred for very long leases (10+ years) where fixed % might diverge too far from market reality.
Market review (highest variance)
Every review, an independent commercial valuer sets rent to prevailing market. Can be a huge upside if you buy in an area on the rise. Can be brutal if the area softens.
Best for: Investors buying in areas with genuine upside, and who can weather down-review volatility. Not for cash-flow-critical portfolios.
Hybrid (increasingly common)
Combines predictability and market alignment. E.g. Fixed 3.5%/yr with a market review at each option renewal (year 5, year 10). Best of both worlds if drafted well.
Best for: Balanced-risk investors, most common in institutional commercial leases.
How review clauses affect cap rate
The market values commercial property on income risk. A lease with predictable 4% fixed escalation is lower risk than one with uncertain CPI + non-ratchet. Lower risk = lower cap rate = higher property value.
Practical impact: two identical retail strips with the same starting rent, one with fixed 4% + ratchet, one with non-ratchet CPI. The fixed-escalation property might sell at 6.0% cap rate. The non-ratchet CPI property might sell at 7.0% cap rate.
The cap rate arbitrage. Same $45,500 net rent.
The review clause is worth ~$100k of purchase price on a $650-750k deal. That's the value piece.
Practical DD checklist
- Read the review clause first, not the headline rent. Confirm mechanism (fixed / CPI / market / hybrid).
- Confirm ratchet. If CPI or market, verify up-only. If not, negotiate or discount.
- Look at WALE. Longer lease + strong review mechanism = compounding value.
- Model your projection with the actual clause. Not "3% growth." The clause. Fixed 4% is different from CPI-linked and different again from market review.
- Check make-good clauses. When tenant leaves, what do they leave behind? Landlord may need to refurb before re-letting.
- Understand option renewal terms. Are options tenant-favourable (they can renew or not) or landlord-favourable (they must renew at pre-agreed rent)?
How the tracker models this
StratMap's commercial engine accepts:
prop.lease.expiryYear: initial lease expiry from purchase (e.g. year 4 or 5)prop.lease.stepPct: % step at each option renewal (e.g. 3.5% or 4%)prop.lease.optionsRemaining: number of options tenant can exerciseprop.lease.uplifts: explicit uplift schedule for known future events
You enter the lease structure, the engine compounds the rent through your projection, and the impact on 10-year cash flow shows in your Money page and Portfolio charts. Two commercial deals with the same starting yield produce different projected outcomes because the tracker models the clauses, not just the headline.
The takeaway. Commercial DD without lease clause modelling is like buying residential without checking the cash flow. Everyone would know that's madness for a residential purchase. The commercial equivalent is checking cap rate but not the review mechanism. Same mistake, same magnitude of value loss.
The compliance frame. Commercial lease terms are legally binding contracts. This article covers common structures; individual leases vary widely. Have a specialist commercial solicitor review every lease before purchase. This article is educational, not legal advice.