There are a number of key matters that should always be considered before taking a lease of commercial property. It is vital to have regard to these issues at the outset before agreeing terms in principle with the landlord, as once these have been agreed you will find it difficult to backtrack on them.
A failure to give proper consideration to one or more of these matters could leave you with a property unsuited to your business and/or an uncommercial and onerous lease. Once you have agreed the principal terms with the landlord typically these would then be documented in formal “heads of terms”, which the parties’ respective solicitors will use as a basis for drafting and negotiating the lease.
We have listed below our top 10 matters to consider before taking a lease.
1. Use of the Property
You must ensure that you will be able to use the property for your business. Is your intended use lawful under planning law, and if not, will you be successful in an application for change of use? If you are taking a lease of part of a building, think about what rights you might need. Will you need access to the roof to install plants and equipment, the right to require your landlord to grant a wayleave to a telecoms operator, or any other rights over the building? You should also consider the extent of the property and whether it includes all the areas and facilities that you require.
2. Repair obligation
Most modern leases require the tenant to keep the property in good and substantial repair and condition, which is an obligation that goes further than many realise. If you take a lease of a property in disrepair, you might immediately be in breach of the repair obligation and therefore need to spend money on repairs to become compliant. For this reason we strongly recommend that you have the property assessed by a surveyor. If you have concerns about the physical state of the property you may want to negotiate for a schedule of condition, the purpose of which is to qualify your repairing obligation by fixing the standard of repair, usually by reference to the condition of the property at the date the lease is granted.
3. Term of the lease
The agreed length of term will be influenced by many factors, including trends in the rental market, the state of the wider economy, the needs of your business and the bargaining power of the parties. Are you looking for short-term occupation or a longer-term commitment? With a longer term you will have greater security of occupation and can justify higher expenditure on your fit out or other works to the property. On the other hand a short-term lease will provide the flexibility to adapt quickly to the needs of your business or changes in the market. The longer the term, the greater the financial commitment and risk. To mitigate this you could negotiate for a break option, which is a right to terminate the lease – either on a fixed date or on a rolling basis - before the end of the contractual term. The exercise of a break option typically requires certain pre-conditions to be met, such as payment of rent. It is important to take legal advice here as landlords often try to impose onerous pre-conditions to make the exercise of the break option as difficult as possible.
4. Security of tenure
Whether a tenant has security of tenure will be a fundamental point for both landlord and tenant. Security of tenure is a statutory right for the tenant to remain in occupation at the end of the term and to the grant of a new lease. The parties are free to agree the terms of the new lease but in the absence of agreement, either party can refer the matter to court to decide the terms. This protects a tenant from a landlord imposing onerous new terms or arbitrary rent increases on renewal. These rights can only be defeated by the landlord proving certain statutory grounds, the most common being that it wants to develop the property or take up occupation itself. A tenant who agrees not to have security of tenure and takes a "contracted out" lease is giving up these valuable rights. They must either vacate the property at the end of the term or negotiate a renewal with the landlord without the safeguards mentioned above.
5. Alterations
Landlords will generally want a high level of control over what alterations can be made to their property. A common market position is for structural and external alterations to be absolutely prohibited, with internal non-structural alternations permitted, subject to landlord’s consent (which is not to be unreasonably withheld). There may also be some types of alterations which are allowed without consent, such as installation of demountable partitioning. The key points to consider are: what categories of works will be permitted and are these sufficient? Will the landlord require a formal licence on each occasion which will typically be at your cost and can cause delay? Will you be required to remove the works at the end of the term? Always consider what fit out works will be required and seek the landlord’s consent to these at an early stage.
6. Assignment/subletting
In the current economic climate flexibility is paramount. Ideally you would want an unfettered ability to deal with the property as suits your requirements, but that is unrealistic in the context of commercial leases where landlords require some degree of control. At minimum you will want a right to assign (transfer) the lease and sublet the property (and perhaps sublet part of the property if the property is suitable for subdivision), but this will invariably require landlord’s consent and be subject to conditions. A common condition on assignment is to require the outgoing tenant to guarantee the obligations of the new tenant. Under such a guarantee, as the outgoing tenant you could be liable to pay the rent after you have parted with all interest in the lease. You may also want the ability to share occupation of the property with concessionaires or franchisees and if so, you should ensure this is allowed under the terms of the lease. In leases with shorter terms, it is not uncommon for the right to sublet (and possibly to assign) to be prohibited altogether.
7. Rent, deposits and rent review
Historically rent has been paid quarterly in advance but it is becoming more common for landlords to agree to monthly payments, especially in shorter leases. Landlords may require a rent deposit if they are concerned about the ability of the tenant to meet its lease obligations. This is a sum, usually equivalent to three or six months’ rent, held as security by the landlord for non-payment of rent or other breaches of covenant. In longer leases there may be a mechanism for the rent to be increased to take account of inflation and increases in the value of property over the term. These increases can be predetermined at the outset by what is called a "stepped rent". Alternatively rent review provisions can provide for an open market valuation or for the rent to be increased by reference to an inflation index (e.g. the RPI) at certain intervals; but in either case they are most likely to be "upwards only", which means that the rent will never decrease following a review.
8. Incentives
Depending on the state of the market, landlords may offer various incentives to attract a tenant. These can include:
- Rent free or reduced rent periods - these usually reflect the length of time required to carry out fit out works, as during this period the tenant won’t be generating any income from the property.
- A capital contribution towards any works that the tenant intends to carry out - this is particularly relevant if the property is in disrepair or the tenant will be carrying out substantial improvements.
- Subsidised services around the building such as discounted canteen food or parking for employees.
9. Other payments
Unless the annual rent is truly an "all inclusive" rent, it is not going to be your only property related overhead. Other outgoings may include:
- Business rates
- Utilities
- Buildings insurance, or more likely a proportion of the landlord’s costs of insuring the property, which would typically include an amount to cover loss of rent for a period (usually two or three years)
- A service charge, if the property is part of a managed building or estate, to cover the landlord's costs of providing services
Each property is different and therefore before committing to take the lease you should establish what other payments will be charged and budget for these costs. If you have concerns about service charge costs you could ask for a cap or even an inclusive rent.
10. Stamp Duty Land Tax (SDLT)
SDLT may be payable on the grant of a lease. The amount of tax is calculated on the "chargeable consideration" paid for the lease; typically the rent and any premium but it could also include other things like paying off debt. Whilst there are online calculators available, these are not always suitable, particularly for more complex transactions. Depending on the nature of the transaction, property and/or parties involved, there may be reliefs or exemptions available. There are different deadlines for filing a return depending on whether the transaction is merely "notifiable" with no tax due, or tax is payable. If tax is payable, it will need to be paid within 14 days from completion of the lease. Failure to file a return and/or pay tax on time will result in your incurring penalties and interest. For all these reasons we would always recommend professional advice is taken.
The above is intended as a brief synopsis of some of the main points you may want to consider and is not intended to be a comprehensive list. Our real estate team can advise on all manner of issues that you may encounter in connection with the taking of a commercial lease.
Daryl Rivero
Jack Lightburn