A ratchet clause, commonly found in commercial lease agreements, is a provision that prevents the rent from decreasing, even if market rents in the area decline. Essentially, it acts as a one-way street, allowing the rent to increase when market conditions improve but preventing it from decreasing when conditions worsen.

Here's how it works: Let's say a commercial property lease includes a ratchet clause. During the lease term, if market rents in the surrounding area rise, the landlord can adjust the tenant's rent upward to match the current market rate. This ensures that the landlord benefits from favourable market conditions.

However, if market rents decrease or stagnate, the ratchet clause prevents the tenant's rent from being reduced to reflect the lower market rates. Instead, the rent remains at its current level or continues to increase according to predetermined terms specified in the lease agreement.

Ratchet clauses are typically advantageous for landlords as they provide a degree of protection against rental income loss during economic downturns or periods of declining market rents. However, they can pose challenges for tenants, especially if they find themselves paying above-market rates while neighbouring properties enjoy lower rents.

For commercial tenants, it's crucial to carefully review lease agreements and understand the implications of any ratchet clauses included therein. Negotiating the terms of the ratchet clause or seeking alternative lease structures that provide more flexibility in rent adjustments may be advisable to mitigate potential financial risks.