Sean Logan from law firm Hart Brown, gives advice to Landlords on legal considerations when negotiating a commercial lease
So you’ve decided to take the plunge and join those already investing in commercial property.
In order to safeguard your investment it is vitally important that the leasing arrangements provide the necessary protection. Commercial leases are fairly standard, however, when the terms of the lease are negotiated there are a number of provisions that a landlord should consider. The main provisions are explored in more detail below:
The Landlord and Tenant Act 1954
The Landlord and Tenant Act 1954 gives the tenant of business premises an automatic right to renew its lease at the end of the term – subject to a small number of grounds that the landlord can rely upon to oppose a new lease.
When granting a new lease a landlord is able to follow a contracting out procedure excluding the relevant renewal provisions of the 1954 Act. As a result, the landlord is free to deal with the property as it wishes at the end of the term, which could include renewing the lease with its existing tenant.
A lease granted inside the provisions of the 1954 Act could be deemed as a lease having no end date. This effectively ties up the property and could devalue the landlord’s interest should the decision be made in the future to sell the freehold. Also, should the landlord wish to oppose a new lease, for example on the ground of redevelopment, the landlord is required to pay the tenant compensation. This can be significant.
Rent Review
Landlords are still able to enforce upwards-only rent reviews, which mean that when the rent is reviewed it will either increase (usually to the then open market) or remain the same. This will protect against future interest rate rises and the resulting increase in mortgage repayments.
A 5-yearly review of the rent is generally accepted.
Repairs and Insurance
Most commonly a commercial lease will be granted as a full insuring and repairing lease. Consequently, the tenant will be responsible for all upkeep of the property and insurance costs.
Where the property forms part of a building, the tenant will usually be required to contribute towards a proportion of the costs of common items and repairs. This has the benefit of closing any gaps that would prevent the landlord from recovering 100% of the expenditure relating to the property.
A landlord would be well advised to keep an eye on the repair and condition of its property. A standard lease should give the landlord a right to serve notice on its tenant at anytime during the term to bring the property up to the standard required by the lease. Nevertheless, should the landlord fail to do so the tenant will be required to yield up the property at the end of the term in the condition required by the lease. A competent landlord will serve on the tenant a schedule of dilapidations detailing the repair and decoration that is required.
Rent Deposit/Guarantee
Assuming that the tenant will be a company a landlord would be well advised to obtain not only a rent deposit but a personal guarantee, given by a parent company or one or two directors of the tenant company. For obvious reasons these will be greatly resisted by the tenant and ultimately decided by the relative bargaining power of the parties.
A novice landlord may very well be tempted to dispense with guarantee provisions in order to secure a tenant. However, this could be a very costly mistake, especially where the tenant is a new company.
It is understandable that a new company will not wish to tie up large sums of money but it is those tenants that pose the highest risk of default. As a compromise a landlord may agree to forgo the deposit provided a guarantee is given, though this will not be an option where the tenant is an individual (as opposed to a company).
The Code for Leasing Business Premises in England and Wales 2007
A landlord should familiarise itself with the Code for Leasing Business Premises in England and Wales 2007 as this may very well be cited by a prospective tenant.
The Code aims to achieve a fairer balance between the landlord and the tenant and is designed to give each party the information necessary to negotiate the best deal possible. Whilst at present the Code is voluntary and a landlord can choose not to offer a Code-compliant lease, there can be no excuse for not acting in the general spirit of the Code.
With respect, your comments re upward-only rent review could be misconstrued.
With ‘upward-only’ there are two separate points. Assuming to the review is to market rent, there is 1) the market rent and 2) the actual rent payable after the review is agreed or ascertained.
The ‘upward-only’ has no bearing on the market rent, so an increase should not be assumed. I find when acting for inexperienced investors or landlords for whom the review is a first-time experience, it is common for them to equate ‘upward-only’ with increase. It doesn’t help that in the media commentators are prone to contributing to the wrong impression as well.
All that ‘upward only’ means is that the rent passing (payable) before the review is unlikely to be less than the rent payable after that review. The market rent itself might be greater or not or the same as the rent passing.
It is only after the market rent is agreed or ascertained (if the dispute resolution procedure were used) that the upward-only ‘cushion’ means the rent payable after the review is not usually any lower than before.
I say ‘unlikely’ and ‘not usually’ because there is an exception. When the rent payable before is based on some previously agreed fixed increase(s) at set intervals, the wording of the agreement for such uplifts is important. For example, if the rent before were £20,000 pa rising to £22,500 pa after year 3, rising to £25,000 pa until the next review and if the market rent at that review were £18,000 pa then £25,000 pa would only continue to be payable (after the review) if there were no wording in the agreement otherwise. Where there are fixed uplifts preceding a rent review, it is important to check the wording of the previous agreement in case the rent payable after the market rent is agreed or ascertained could be lower.
A rent review is usually documented in a memorandum signed by the parties. Even if the rent payable after the review were the same as before, to document the market rent at ‘nil increase’ (a common tendency amongst those that can’t be bothered to agree the market rent by reason of commercial expediency) is not evidence that the market rent would have necessarily been any lower. Nil increase doesn’t mean the premises are overrented; all it means is that either the market rent is the same as the rent passing or the parties didn’t think the review worth pursuing by reason of costs, etc.
Whether to specify the market rent or the rent passing in the memorandum is important in the context of any mortgage/funding arrangements. A landlord that wants the lender to think all is well won’t want to have a lower market rent documented because that sends out the wrong message. However, whether the tenant will play ball depends on how lazy is the tenant’s surveyor and/or shrewd thinking. Well-advised tenants are more likely to either insist on the market rent or want some concession in exchange for helping the landlord to keep up appearances.
I appreciate your article is only intended as an overview but since it’s written for those taking the plunge I think it important to ensure people are aware of the facts, if only to avoid giving the wrong impression and coming unstuck.
Michael Lever
The Rent Review Specialist
Established 1975
Comment by Michael Lever — 22/2/2013 #