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Jun, 2017

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  1. Default Investing in Commercial Property - (1) for Income

    There are probably only three reasons for investing in commercial property, of which one does not apply to most landlords. The exception is a non-arm's length transaction, where the tenant is connected to the landlord; for example, a group company subsidiary leases premises from the parent company, or the landlord's business occupies the premises and rent is for tax accounting. Otherwise, the other two reasons are for income and/or capital growth. In the next article, I'll write about investing for capital growth, but here I focus on income.

    With commercial property (shops, offices, industrial, leisure, anything involving a business tenancy), income comes from two sources. Primary income is rent. Secondary income from opportunities that might arise during the management of the tenancy.

    Primary income, or rent, comprises the rent for the premises and any additional items that are defined as rent in the lease, such as the building insurance premium, and the service charge.

    With additional items, generally, the scope for making a profit out of the difference between the insurance premium payable by the tenant and the premium payable by the landlord to the insurer comes from block policy discounts, insurance policy commission, and blatant fiddles such as overcharging the tenant on proportionate share. With a service charge, profit possibility stems from being able to charge a percentage for managing the property, and carrying out any work that the charge covers without needing to use third-party contractors.

    Secondary income can arise during the management of the tenancy. Depending upon the wording in the lease, and whether the tenant requests something of the landlord (for example, change of use, assignment, underletting, alterations, use of elevations for advertising hoardings, roofs for satellite dishes and such like, variation to the lease), it may be possible for the landlord to charge for consent, either for the consent itself and/or for administering consent. Even when the lease or overriding legislation states the landlord's consent cannot be unreasonably withheld, that does not rule out the possibility of being able to charge costs for that consent. The "extras" can mount up.

    The (main) rent for the premises starts as a matter of agreement between the parties on grant of a new lease. Thereafter, unless the renewal of the tenancy is outside LTA54, on grant is the only time rent is solely a matter a matter of agreement (take-it-or-leave-it), otherwise it might be ascertained by an impartial third party in a dispute. Only when the tenancy is outside LTA54 would the new lease again be a matter of agreement, take-it-or-leave-it.

    Depending upon the duration of the tenancy and/or what was agreed by the parties, the rent may be subject to rent review. Whether the rent increases at each review depends upon the type of review clause. In most leases, rent reviews are to market rent, subject to a cushion (known as an 'upward-only' review) whereby the rent payable after the review is agreed or ascertained would not be less than the rent previously payable. Other types of rent review include preset increases, index-linked,...

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    Last edited by LandlordZONE; 13-01-2016 at 16:21 PM.

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  3. #2

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    Hi, I'm a landlord with a commercial lease expiring in 2 years. Did I understand correctly that the renewal with be at 'market rent' which could be lower than current only if an agreement can not be reached? Also, you mention a way to avoid the LTA 54 upon expiry, could you detail this a little more? Many thanks on producing a very interesting article.
    Answers given are simply my own opinion and should not be interpreted as legal advise. Always seek legal assistance if you have any doubts.

  4. #3
    Join Date
    Oct 2012
    Location
    England
    Posts
    359

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    I apologise for the delay in replying: only just looked at this thread!

    Yes, on renewal (per LTA54), the rent would be the market rent regardless of the previous rent (jn the expired lease). Furthermore, the definition of market rent is per s34 and s35 LTA54, regardless of the definition in the expired lease. Also, on renewal any interim rent for the period from the end date in the notice and renewal term commencement date could also be lower if it could be shown that at the interim rent valuation date the market were substantially lower.

    It is not always easy to realise that the passing rent might have resulted in the property becoming overrented. For example, assuming term 10 year from 2006, rent review at year 5, the initial rent in 2006 was increased at the 2011 review. To have bought the investment at any time after the 2011 review was agreed/ascertained on the assumption that rent would presumably have been the same had there been a rent at any time between the 2011 review date and the lease expiry date is a mistake. The question when buying an existing investment where the next opportunity for review is not protected by an upward-only provision is what the rent would've had been at the investment purchase date. Not thinking in that way is why it is often a shock to the investor's system when on expiry the rent falls, or if the tenant having gone bust the premises are unlettable at at least, the same rent as before.

    That the market rent on renewal might be lower than the previous rent passing has implications for index-linked reviews. Where in the expired lease the rent reviews are index-linked, the inflation adjusted rent could end up much higher than the market rent. In principle, the tenant is entitled to renew on broadly the same terms and conditions as the expired (any changes no more onerous) so while the rent reviews in the renewal lease could continue to be index-linked, the initial rent for the renewal lease would still be the market rent.

    Assuming the tenancy is not outside LTA54 to begin with, the way to avoid LTA54 on expiry is to negotiate renewal terms before the earliest date that a statutory notice could be served. That would require the tenant's co-operation of course. Another way commonly used is to restructure the existing lease a few years before the contractual expiry, again that can only be done by agreement. Either way the proposed agreement would be subject to contract, which means either party could withdraw before completion.

  5. #4
    Join Date
    Jun 2015
    Location
    London
    Posts
    10

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    Thanks all very useful as I am looking to rent some offices out myself.

    Lots to think about but I am getting there slowly.

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