Most commercial leases contain an obligation on a tenant to remove any alterations made to a property before returning it to the landlord at the end of the term.
The requirement for a tenant to remove its alterations and strip the property back to shell at the end of the lease is a very standard term, and rarely is it hotly negotiated, but is the obligation to remove a fit out which is not at the end of its useable life a sustainable one?
The problem.
The yield up obligation is often unqualified, meaning a tenant is obliged to remove its fit out even if it is new, serviceable or readily adaptable. Any construction process is inherently wasteful. The fit out – strip out cycle is open to criticism that it generates waste and is environmentally inefficient.
If tenants were not obliged to remove their alterations at the end of every term it could have the potential to encourage incoming tenants to repurpose the existing fit out (therefore reducing waste) rather than commencing anew at the start of every lease term.
However, institutional landlords expect a tenant to strip out to ensure that they get the property back in a condition which allows them to immediately re-let. Marketing with a fit out in situ is arguably harder than marketing a blank canvas. The requirement is there to protect the investment by minimising void periods and maximising the attractiveness of the property to a wider audience. Landlords will want to avoid an incoming tenant expecting a rent free period or some other incentive to cover their start-up costs whilst the space is reconfigured.
The problem is perhaps more acute for tenants who exit premises pursuant to a break clause which is conditional on giving up occupation or giving vacant possession at the end of the lease. Those tenants will often remove their fit out even if it could be repurposed in order to be certain of meeting the break requirements. A tenant won’t want to take the risk that a landlord says the break condition hasn’t been complied with and the lease is continuing, so the safest option is to take everything out even though that could generate a lot of waste.
The guidance in the RICS code for leasing says vacant possession should no longer be an acceptable condition to the exercise of a break option but even some less onerous conditions (for example requiring a tenant to give up occupation) might in some circumstances require good quality fit out to be removed.
What are the alternatives?
1. Fixed dilapidations payments in lieu of reinstatement
One option is a fixed dilapidations payment in lieu of reinstatement obligations. Instead of a tenant being required to remove its fit out as standard, instead a landlord would be able to call for a payment only in the event the fit out has to be removed because it can’t be reused. A landlord would then be protected in the event it does have to offer incentives to an incoming tenant because the fit out isn’t suitable to be recycled, however, if the fit out can be reconfigured or recycled a tenant wouldn’t have to pay anything.
The problem with this model will be agreeing who decides what is reusable and how much a payment should be. It will be difficult for those assessments to be made at the beginning of the lease without knowledge of the market at the end of the lease.
2. Mandatory Collaboration
Another alternative is for there to be mandatory collaboration prior to lease end to ascertain what parts of a tenant’s fit out are re-usable and marketable and what fit out should be removed.
Under the current dilapidations model a landlord instructs a dilapidations surveyor to prepare a schedule which identifies wants of repair, decoration and reinstatement that a tenant is responsible for before the end of the lease. Arguably that process could involve an assessment of what amongst the existing fit out is reusable, adaptable and of no detriment to the re-marketing of the property, so that it might remain in situ in the interests of sustainability. The assessment itself is likely to be time consuming, costly and subject to some value judgment so might only be appropriate for leases of a certain term or value, but this might be a starting point to encourage collaboration.
Some surveyors are already offering schemes whereby landlords and tenants can agree to determine their dilapidations liabilities by reference to green principles and more detail on the TFT scheme is available here: https://ww3.rics.org/uk/en/journals/built-environment-journal/can-dilapidations-achieve-net-zero-carbon-.html
3. A call for reasonableness?
A final option is for landlords and tenants to agree that what it is reasonable to require a tenant to remove requires an assessment of what can be recycled and reused.
We already see many leases where a tenant’s obligation to reinstate only applies where reasonably required by the landlord. Where leases contain that qualification, could landlords and tenants accept that it is not reasonable to require reinstatement if a tenant’s fit out might be reconfigured and re-used by an incoming tenant in the interests of sustainability? In particular, where a landlord has stated environmental commitments it might be unreasonable for that landlord to refuse to allow good quality fit out to remain.
Will yield up change?
The pandemic has accelerated a push towards shorter lease terms. Tenants who are leasing for shorter terms may start to resist an unqualified obligation to reinstate. However, wholesale change is unlikely to be on the cards in the short term, as changes to standard leasing expectations will need to be driven by institutional investors who set the market for acceptable leasing terms.
In the meantime, landlords and tenants can still take action to reduce waste in a positive way. Tenants and occupiers can try to install recycled racking and partitioning and to source sustainable furniture and fittings. Tenants can look at installing fit out which is less bespoke and suitable for reconfiguration for the growth of the business or for future operators. When installing M & E looking for items which are suitable for repair will also minimise waste. Tenants and occupiers might also consider renting fixtures and furniture which can be returned at the end of the lease term.
However, perhaps the most significant contribution that can be made by leasing parties and their professional advisors is to commit to open and early engagement to collaborate together to minimise waste.
The more parties can do to understand each other the more that can be achieved to reduce the carbon impact of the fit out - strip out cycle.
Stephanie Newton
Helen Wheddon