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Ratchet clauses: what they really mean.
Among the most important, and often overlooked, parts of a commercial lease. Understanding how they work can save you significant money over your tenancy.
Ratchet clauses are among the most important, and often overlooked, parts of a commercial lease. Included in the rent review provisions, they can significantly impact the total rent paid over the course of a tenancy.
This article expands on our understanding commercial rent reviews overview and concentrates solely on ratchets: what they are, how they function in standard New Zealand lease forms, and what to consider before you sign.
What is a ratchet clause?
A ratchet clause is a rule in a lease that limits how far the rent can fall at a rent review, or whether it can fall at all.
Without a ratchet
A rent review (usually a market review) can move the rent up or down, depending on the market
With a ratchet
The rent can usually move up, but any downward movement is restricted or blocked by the wording of the clause
How Ratchets Work
Rent CAN increase
Always permitted at review
Rent CANNOT decrease
Restricted or blocked by ratchet
One-way mechanism
Like a ratchet wrench - turns one direction only
Why ratchets matter.
Ratchets shift risk between landlord and tenant in a very direct way. The differences compound over time.
For Landlords
Ratchets provide:
- Protect the rental stream if the market softens
- Help support the property's value
- Make the lease more attractive to lenders
For Tenants
Ratchets can mean:
- Diminished benefit of rent reviews in a downturn
- Rent unchanged even when comparable premises rent for less
- Paying above-market rent for extended periods
Financial Impact
Because of this risk shift, ratchets are often one of the most financially significant parts of a lease. The differences compound over time, especially across multiple renewal terms.
Main types of ratchet clause.
While wording varies between leases, most ratchet clauses fit into these patterns.
No-Decrease (Hard) Ratchet
The rent cannot be reduced on review. If the market rent is lower than the current rent, the rent simply remains as it is. This provides maximum protection for landlords but offers no relief to tenants in a falling market.
Impact
Tenant pays current rent even if market has dropped significantly
Floor (Soft) Ratchet
The rent can decrease, but only to a set minimum, often the rent that was in place at the start of the current lease term. Below that minimum, no further reduction is permitted.
Impact
Some downward flexibility, but with a protected floor level
Commencement Ratchet
The rent can never fall below the rent that applied at the start of the original lease. This offers strong long-term protection for landlords, especially when the same tenant renews over many years.
Impact
Floor is locked to original rent across all renewals
Cap and Collar (Custom) Ratchet
The lease sets limits on how much the rent can increase or decrease on any review (for example, maximum 10% increase and maximum 5% decrease). This allows rent to move both up and down, but within a controlled band.
Impact
Both parties share some risk; movement limited in both directions
A practical example.
Initial rent: $50,000 + GST per year. After 3 years, market rent review shows fair market rent is now $45,000.
| Ratchet Type | New Rent | Tenant Impact |
|---|---|---|
| No ratchet | $45,000 | Tenant shares fully in softer market |
| Soft ratchet (floor at $50,000) | $50,000 | No decrease despite lower valuation |
| Cap and collar (max 5% decrease) | $47,500 | Partial decrease only |
These differences compound over time
Which is why ratchet wording deserves close attention
Common traps.
Assuming 'no selection' means 'no ratchet'
In some standard forms, a soft ratchet is treated as the default if nothing is chosen in the schedule. Leaving boxes blank can still result in a ratchet applying.
Overlooking CPI formulas
Wording that says the CPI factor must not be less than 1 is effectively a hard ratchet on a CPI review, because the rent can never decrease under that formula.
Not noticing how the floor is defined
Some ratchets look back to the rent before the review, some to the rent at the start of the current term, and some to the rent at the beginning of the original lease. That choice affects how strongly the ratchet protects the landlord.
Negotiating ratchets: practical tips.
For All Parties
Identify every type of rent review in the lease and check which ratchet option has been selected for each
Read the underlying wording, not just the tick-boxes, so you can see exactly how any floor, cap or collar is defined
Model some simple 'what if' scenarios, including a downturn, so you can see how the rent would move in dollar terms
As a Landlord
Consider whether hard or soft ratchets, or a collar on decreases, are needed to protect your income and asset value, balanced against what the market will accept.
As a Tenant
Focus on preserving the ability for rent to fall to the true market level at key points (at least on renewal) or on agreeing caps and collars that keep movements within a manageable band.
Key Takeaways
Ratchet clauses limit or prevent rent decreases at review, shifting risk to tenants
Hard ratchets prevent any decrease; soft ratchets set a floor; caps and collars limit movement in both directions
Default settings in standard forms may include ratchets even if not explicitly selected
CPI formulas can contain hidden ratchets through their wording
Model scenarios to understand the financial impact before signing
Related Guide
Understanding ratchet clauses is key to negotiating a fair lease. Our guide covers all the terms you need to know.
Read the Commercial Lease GuideRelated Reading
Understanding rent reviews in commercial leases
What rent reviews are, how they work, and why the review mechanism in your lease matters. Covers market reviews, CPI adjustments, fixed increases, and ratchet clauses.
Commercial lease review: What tenants must check
Commercial leases have no consumer protections. Before you sign, understand what you are committing to and the clauses that could cost your business.