Value of the Diplomatic Clause

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carteki
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Value of the Diplomatic Clause

Post by carteki » Wed, 04 Jan 2012 1:40 pm

I was having a discussion with a friend over the renewal of his lease and she was somewhat concerned about the increase that was coming her way. During the discussion I thought about the diplomatic clause and suggested to her that as part of the negotiations this had very little value to her and that she should tell the LL that she'd remove it from the contract. Shock - horror - no - I couldn't do that - was the initial response, but once I'd talked it through it made sense.

For each person the Diplomatic Clause will have a different value and I thought I'd try to show some ways that you can use to decide if the clause is worth keeping or not.

In general, a diplomatic clause allows the tenant to break the lease agreement after 50% of the time has passed with little / no penalty to the tenant. As a result of the diplomatic clause the LL bears the WHOLE cost of the broken contract. We've seen on the forum instances where the LL has not allowed a replacement tenant. It is unlikely that the courts will uphold this attitude as the purpose of the contract is to protect against financial losses

What is that cost?
Given that a prorata commission is recovered from the tenant I'm not going to include a commission cost.
The costs are:
1) Of the property staying empty for a month - 3 months before a tenant is found
2) Any decrease in the monthly rentals over the original contract value for the remainder of the original lease term.

In the case of my friend we can calculate that the cost of the property staying empty for 2 months is $21k and I'm assuming that they'll be able to re-rent the property at least at the rental that they're paying so no cost for point 2.

So the cost could be $21k or it could be nothing. In the financial world probabilities of events occurring are applied to these costs to get an "option cost".

In the specific example of my friend... They've been in the property for 2 years and they like it there. They've been in SG for 4 years and have another 4 years remaining on his contract. He enjoys his job and it is unlikely that he's going to change it / leave etc. Their plan is to stay in Singapore for the full term of the lease and it looks like this is probable. I have applied a factor of 5% to the probability that something will happen - illness, death, disaster - that will result in them having to move. Therefore in this particular circumstance the value of the option is $1050 ($21k x 5%) or less than $100pm to them - but the LL probably feels that it costs him way more because he doesn't know the individual circumstances of the tenant. The cost to the LL could be about 20-50% in my mind. So therefore there is room to bargain.

I've estimated that there is a 5% chance that they could land up having to shell out $21k in the event of an unforseen circumstance, although it could be less than that.

The factor is unique to every circumstance. I've just used an example here. For some people the 5% chance that they could land up having to spend $21k is too much uncertainty and they would prefer no chance.

And the result of my friend's negotiation? Well the rent remained unchanged, but the diplomatic clause was removed.

Interested to hear your thoughts and ideas on this.

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Post by stueyhall » Wed, 04 Jan 2012 2:40 pm

I'm interested in the mechanics of the diplomatic clause and activating it as I am about to sign a lease myself. I am only going to be in singapore for 18 months and would like to sign a lease to match. However I've had the standard we only do 1 year or 2 years with the diplomatic clause. To me it seems absurd I would sign a 2 year contract knowing 100% i will have to activate the clause and likely have cough up the commission to the landlord (2 weeks?).

Question what do you actually need to evoke the clause ie written confirmaiton of transferring country and can you just give two months notice and say the clause is in play?

Curious to hear some thoughts on how the clause operates in practive and also whether I am having a laugh trying to sign an 18 month lease?

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Re: Value of the Diplomatic Clause

Post by x9200 » Wed, 04 Jan 2012 3:10 pm

carteki wrote: In general, a diplomatic clause allows the tenant to break the lease agreement after 50% of the time has passed with little / no penalty to the tenant. As a result of the diplomatic clause the LL bears the WHOLE cost of the broken contract. We've seen on the forum instances where the LL has not allowed a replacement tenant. It is unlikely that the courts will uphold this attitude as the purpose of the contract is to protect against financial losses
The contract is to define and fulfill the obligation and this may not be fully on a tangible financial ground. Also in every single agreement there is a risk involved. Here, this is also the tenant who takes the risk of premature termination of the contract (within the initial period) so IMHO all together it is reasonably balanced and I don't think the court will see it very differently.
carteki wrote: And the result of my friend's negotiation? Well the rent remained unchanged, but the diplomatic clause was removed.

Interested to hear your thoughts and ideas on this.
I think it is very much to the agreeing parties (individuals). With a few TA executed already I have never felt that the diplomatic clause is of any serious concern to my LLs. It is not to that extent that I am PR and still have it in our current TA. As I said, I think it fairly balances the risk between the landlord and the tenant especially for the non-residents. If under the specific circumstances of your friend / her LL she found it beneficial than of course it was desirable to trade the clause off for some other benefits but I don't think it is generally advisable and justified to recommend this approach.

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Re: Value of the Diplomatic Clause

Post by JR8 » Wed, 04 Jan 2012 7:01 pm

carteki wrote:During the discussion I thought about the diplomatic clause and suggested to her that as part of the negotiations this had very little value to her and that she should tell the LL that she'd remove it from the contract. Shock - horror - no - I couldn't do that - was the initial response, but once I'd talked it through it made sense.
As I read through your post my thought was that I bet the LL would respond in the same way if you suggested a discount for foregoing the DC.

In part I think it comes down to what kind of LL there is and who deals with the negotiation. I suspect most LLs would not be interested in or understand such analysis and hence the reason for negotiation. Time is money. In my own experience if a tenant came to me with such a 'worked through' non-standard proposition I would take it as quite a warning sign against their character, i.e. 'Jeez [sigh], why can't they just deal with things like everyone else does!'. This might be less of an issue with a renewal as by then the tenant is a known quantity, but I'd still wonder why they wished to fiddle with minor detail.


carteki wrote: And the result of my friend's negotiation? Well the rent remained unchanged, but the diplomatic clause was removed.

So the attempt to negotiate for mutual benefit ended with the LL alone getting any gain? Hmmm, not very successful then! :cry:

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Re: Value of the Diplomatic Clause

Post by carteki » Wed, 04 Jan 2012 7:07 pm

JR8 wrote:
carteki wrote: And the result of my friend's negotiation? Well the rent remained unchanged, but the diplomatic clause was removed.

So the attempt to negotiate for mutual benefit ended with the LL alone getting any gain? Hmmm, not very successful then! :cry:
Disagree - the rental remained unchanged from the original contract rental. We've heard tales of 50% increases on the board, so in my mind it is a gain.

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Re: Value of the Diplomatic Clause

Post by JR8 » Wed, 04 Jan 2012 7:28 pm

carteki wrote:[
Disagree - the rental remained unchanged from the original contract rental. We've heard tales of 50% increases on the board, so in my mind it is a gain.
OIC, I'd missed that point. I think a problem though if you're being analytical is that you cannot know if the rent would have been raised, dropped or left the same anyway. Given the financial dung that is going to hit the fan in the coming year or more, maybe a locked-in term of two years at current prices looks like a win-win prospect to the LL?

Did your friend sit with the landlord and go through all those numbers, or did they simply offer nil hike for striking out the DC?

p.s. At the end of the day if everyone has left the table feeling that they have got themselves a good deal... you can't much much better than that

:)

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Post by BillyB » Wed, 04 Jan 2012 11:21 pm

I thought a dip clause is effectively 14 months? (12 +2). Isn't the whole point of that to give the LL 2 months to find someone else?

Also, I don't understand the logic. As an example, assuming the landlord goes off the contract to the letter of the law and doesn't budge, if after 4 months of the new contract they need to leave Singapore;

- With dip clause the penalty would be 10 months, $100k
- Without dip clause, technically they are liable for the remaining 20 months, $200k.

Although it's unlikely that would happen ( I imagine the LL would look for other tenants, but by the letter of the law he doesn't have to) it should be factored in.

Personally, I think your friend has took on way too much risk by removing the dip clause. Singapore will be in recession soon (so industries across the board will feel the pinch) and the landlord is probably rubbing his hands together given the coming housing downturn - 15-20% reduction in prices yet he has achieved the same rental yield guaranteed for 2 years.

But, as JR8 says, if everyone is happy then that's a good negotiation for all involved.

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Post by JR8 » Wed, 04 Jan 2012 11:45 pm

A sidenote:
The last lease I had in SG, I recall discussing a DC but I now see it never ended up in the final version of the agreement.

What we did get though was a clause for a rent review after one year of the two year term. Which in the event resulted in a c.15% cut in what I paid.

------------

In London where I own a handful of long-term rentals, as a rule of thumb rent goes up for existing tenants at RPI (Retail Price Inflation). Only once a tenant leaves does it gets rebased by marking-to-market. Rent never goes down, though I did give my tenants a holiday off the annual review in 2008/2009 due to us all bearing the pain.

This means I have reliable and happy long-term tenants who in general are paying under market, and they know it (even if they act blur), and I know that they know :)

I have nil voids, happy tenants who don't dick me about, and make sure they don't prejudice their position by always paying rent on the nail.

Perfick, I reckon :)

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Post by BillyB » Wed, 04 Jan 2012 11:49 pm

JR8 wrote:A sidenote:
The last lease I had in SG, I recall discussing a DC but I now see it never ended up in the final version of the agreement.

What we did get though was a clause for a rent review after one year of the two year term. Which in the event resulted in a c.15% cut in what I paid.

------------

In London where I own a handful of long-term rentals, as a rule of thumb rent goes up for existing tenants at RPI (Retail Price Inflation). Only once a tenant leaves does it gets rebased by marking-to-market. Rent never goes down, though I did give my tenants a holiday off the annual review in 2008/2009 due to us all bearing the pain.

This means I have reliable and happy long-term tenants who in general are paying under market, and they know it (even if they act blur), and I know that they know :)

I have nil voids, happy tenants who don't dick me about, and make sure they don't prejudice their position by always paying rent on the nail.

Perfick, I reckon :)
Did you throw in your old porn collection as a 'deal-sealer'?!

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