Whether negotiating a new commercial lease, or renegotiating an existing one, it is important to plan ahead and be clear about your desired outcomes and where you have flexibility to compromise.
‘Your negotiating position will be influenced by the attractiveness of your property, competition and market conditions,’ says Ian Cowan, Solicitor in the commercial property team with Richard Reed. ‘But a good lawyer will know which are the essential points for the landlord and concentrate on those, so both landlord and tenant save money and maintain a strong business relationship.’
Rent and rent reviews
Rents can be structured in various ways. Until recently, the most common approach for a commercial lease was a rent fixed for the first five years, with an ‘upwards only’ rent review at the five-year point and, for longer leases, every five years after that. This has worked in favour of landlords, because the rent either increases to match current market rents if they have risen or stay the same. Even if market rents have fallen, the lease rent will not decrease.
In a volatile market this is proving unattractive for tenants who do not wish to be stuck in over-priced premises, paying more than they would if they took a new lease. You may be faced with losing a good tenant if you are not prepared to consider renegotiation.
Tenants, especially those in retail and hospitality, are now more likely to ask for at least part of their rent to be a proportion of their turnover after profit. You may be willing to accept this to secure a good tenant, but it is crucial to get your lawyer to agree a detailed mechanism for calculating the turnover rent. The tenant will want a wide list of expenses that can be deducted from gross turnover before the rent element is calculated, as well as a list of types of income that are excluded altogether. You should seek to limit these items and ensure that there is a notional turnover figure for any normal working days when the tenant chooses not to trade.
The other alternative is to have an index-linked rent, which broadly tracks inflation. In a high-inflation market, these will be more appealing to the landlord than the tenant. The key negotiating point here will be whether there will be upper and lower limits on how far the rent can move. The formulae for calculating indexed rents can be very complex, so your lawyer should also include some worked examples.
Control over assignment and underlettings
You will need some level of control over whether a tenant can assign the lease to another business or create subleases, to ensure the property is always occupied by a reputable and financially sound business. This is largely governed by statute and landlords must act reasonably, but there is scope to negotiate a list of circumstances when you can refuse consent or impose conditions lawfully. These might include outlawing assignments to other companies in the tenant’s group or to companies that will not be able to meet all the tenant’s obligations in the lease, and requiring that the outgoing tenant is up to date with the rent and any other payments due to the landlord.
Typical conditions that a landlord may want to impose include:
- asking the outgoing tenant to guarantee that the next tenant will pay the rent and comply with the lease;
- asking for a guarantor for the new tenant; or
- asking for a rent deposit as security for any rent shortfalls.
Whether or not subletting is allowed is a matter for negotiation. The tenant will want as much flexibility as possible but you should be wary of ending up with a weak business in the property. If you are willing to allow subletting, your lawyer will need to negotiate a limit on the number of occupiers at any one time and make sure that a subtenant is bound by the terms of the lease. This is important, because a tenant may try to agree a less onerous sublease with a subtenant to make the arrangement more attractive. Repairing obligations are often watered down in subleases, so this is something to watch out for.
Repair and maintenance
You will want to make sure the tenant has to keep the property in good repair and that if the tenant fails to do this, you can do the work and recover the costs. The tenant may try to agree a more limited repairing obligation, especially if the property is already slightly dilapidated. If you do agree to this, your lawyer will need to draft the lease to reflect clearly what the tenant is required to do.
Energy efficiency is a key element of future-proofing an investment property. At present, landlords must achieve minimum energy efficiency standards (MEES) before they can lawfully let a property. The minimum level is currently EPC E. The future of this area of regulation is a little uncertain but it is widely expected that the minimum level will rise to EPC C or B in the near future.
This means you will need the right to control tenant alterations, to stop them doing anything that would adversely affect energy performance. That is relatively uncontroversial, but the more difficult issue is whether you will have the right to enter the property to make energy efficiency improvements during the term of the lease. Tenants will usually resist anything that could disrupt their business but the uncertainty over energy efficiency regulation in the future makes this increasingly important for landlords.
The other difficult issue to negotiate will be who pays the costs of energy efficiency improvements. You will want to recover some or all of the expenditure through the service charge, but the tenant may argue that this would allow the landlord to improve the property at the tenant’s expense. In turn, you may argue that the tenant will benefit from reduced energy bills, so should be willing to share the expense. As there is no legal guidance on this issue at present, it is up to the parties and their lawyers to agree the best arrangement they can.
How we can help
Our commercial property lawyers will take a constructive approach to negotiating a lease, focusing on the issues that really matter to you. This should get the business relationship between you and your tenant off to a good start, which should in turn reduce the chance of disputes in the future.
For further information, please contact our commercial property team on 0191 567 0465 or email: [email protected]