Planning issues
Planning use
As well as checking with the local authority that his proposed use is lawful, the tenant should make sure that the landlord knows exactly for what he intends to use the building, and that it is approved. It is important that a tenant considers his future requirements here. It is very easy to change the direction of a business and find you fall foul of your lease. For example, a manufacturer may not at first consider that he might want a cash and carry or factory shop division a few years later. Alternatively, a tenant may want to dispose of the lease to someone who wants to use the building for a different purpose.
The question of user is of course more important in longer leases where the use is much more
likely to change over time. Solicitors for landlords who do not have much property valuation
knowledge, frequently fix the use clause narrowly - perhaps with the thought that if the tenant
needs to change the use in any way he will have to come back to the landlord, and perhaps
pay a fee or more rent for the privilege. He misses the point however that at a rent review the
new rent will be calculated by reference to the rack rent (then current rent) payable in the open
market. Clearly, a theoretical open market value would be lower if the number of potential
tenants is fewer. A landlord should therefore think particularly carefully before imposing a use
restriction which limits a change to a use which in fact provides a lower rental value than some
other potential use. Generally speaking, the wider the use allowed, the greater the rental value. Excluding security of tenure
If the lease is governed by the Landlord and Tenant Act 1954, and most leases are, the tenant has a right to security of tenure. This simply means that they have a right to continue using the property and renew the tenancy on the same terms so long as neither of the parties objects.
Under the new Regulatory Reform Order 2003, a landlord can only refuse to continue the tenancy if the tenant has done one of a few things (see our article on Security of Tenure for full details). One example might be that the tenant failed to make regular payments.
If the landlord is happy for the tenant to continue in occupation under the terms of the original
lease, he should serve a ‘section 25’ notice to that effect.
Issues for landlords
Stamp duty on leases
You cannot use as evidence in court any document transferring an interest in property, unless it has been stamped. That includes a lease. The rate is calculated as a percentage of the average rent for the term. If there are review provisions, the Inland Revenue will generally accept a calculation based on the starting rent. Current rates of duty are:
Length of Term Rate of Duty
Not more than 7 years or indefinite y 1%
More than 7 years but not more than 35 years 2%
More than 35 years but not more than 100 years 12%
Over 100 years 24%
There is no duty payable on a lease for under seven years if the rent is less than £5,000.
Stamp duty is paid to the Inland Revenue, and all your questions can be answered at }
http://www.inlandrevenue.gov.uk/rates/stamprates.htm Registration of your lease
“It is now a legal requirement that the tenant of any new lease for a term in excess of seven years (until recently, 21 years), register the lease at the Land Registry. Conversely, a lease for a term of seven years or less is not registerable. To calculate the fee, multiply the rent by ten, to give a notional capital value. Fees payable at November 2003 are:
Capital value fee
0 - £50,000 £40
£50,000 - £80,000 £60
£80,000 - £100,000 £100
£100,000 - £200,000 £150
Prescribed Lease Clauses
On a lease over seven years, it is now mandatory that you make sure that it contains ‘prescribed lease clauses’ at the top of the agreement. All Net Lawman documents provide for this and explain how to complete the clauses. The PLCs have been designed to speed up the registration process at the Land Registry office. For more information, please read our articles on Prescribed Lease clauses (part one) (part two).
Tenants - lease or buy
When your business requires it's own premises a decision must be made as to whether to lease or purchase commercial property. If the answer is not immediately obvious to you, here are some of the considerations: Starting point - cash flow
Your calculations will be based on interest rates and rates of return on property. Interest rates vary according to the economic cycle and other factors. Rates of return on investment in property vary according to the interest rate cycle, and also to the type of business property. An investor in a substantial shop property in the south of England might expect a return of 5%, whereas an investor in industrial property in the north of England may seek a return of 10% or even 12%. This difference reflects the market's perception of risk.
On a pure comparative cost calculation, you should therefore set out the figures comparing the total cost of being your own landlord, as against the total cost of someone else being your landlord. If you are looking at a rent of, say, £10,000 per year against a purchase at £100,000, then you need to be able to borrow at less than 10% for the cash flow effect of your purchase to be better than the cash flow effect of a lease. (Ignoring capital repayments). Capital appreciation
In the long term the capital value of your purchased property will increase at least in line with inflation. For property, the "long term" can be said to be the life of an average building, so we are talking "long, long term". Even this however, is subject to other influences and trends. Over the last ten years the changing structure of the workforce has reduced the demand for industrial and older business property. Your motor repair workshop may only be worth the same number of pounds today as it was worth ten years ago. In real terms you have probably lost half its value. Even if you use a professional surveyor to advise on today's values, you will still need to take your own view on future values.
In a property lease the risk is taken by your landlord. The rent is likely to be fixed for a number of years, and will then be increased in line with the general level of rents for similar properties.
Property is a solid asset
In the cash flow calculation above, no account has been taken of repayments on any borrowing you took out to fund the purchase. If a large proportion of the purchase price was borrowed from a specialist property lender, with repayments of capital and interest (like your house mortgage), then you may still be able to find a deal which provides a total payment to your lender which is no greater than the sum that you would have been paying in rent. In that scenario, you end up owning your property. That is obviously more attractive than a property lease situation. But if you need to sell your property in bad times, you may not achieve the price you thought it was worth. Flexibility
At the end of a lease you can walk away with no further obligation. If you have to move whilst a lease is still running, you may have problems. You will have to continue to pay the rent - or find someone else to take over the lease from you. If the "someone else" you find fails to keep up payments, then you might find your old landlord knocking on your door instead. Finding a new tenant may be inconvenient. You may find there is a deficiency between the rent you were paying, and the new rent someone will pay to take you out.
In Brief, keep your business property lease as short as you can, or buy a property you are sure will increase in value.
I know all this. Just take me to where I can choose a document to buy. Tenants - tips for negotiating a business property lease
After salaries, the cost of your business lease is likely to be the biggest overhead you have. Because a business lease invariably involves a commitment for a substantial period of time, it is very, very important to get the right premises on the right terms. Here are a few tips:
- Write down absolutely all the features you need in your new premises. Put them in order of importance. Check every property you visit against your list, and make sure you account for any additional cost or disadvantage which each may present.
- Short leases are often called tenancy agreements, but there is no difference in law. You can fix your deal for any period you like. If your landlord likes the thought of your becoming a tenant he will ask for a long term. If you do not wish to be tied then you will negotiate a short term. Start with the deal that you would like, not the one that is presented to you.
- Business property tenants have less statutory protection than residential tenants. (But see below). Most commercial landlords are either professional landlords or use professional agents, or both. They are experts in every aspect of commercial property. You may not be. Most commercial agents are also experts at negotiating lease terms on behalf of their clients. Again, you may not be.
- The main effect of the comparatively free market in commercial property is that "everything is up for grabs". If the agent or landlord thinks you are likely to take the property on offer it is unlikely that they will move on the terms. If you make it clear that you have several alternatives, then you will find that the previously "fixed" terms suddenly become very flexible. Much depends too upon the state of the market. A landlord may well be tempted to hold out for his set price and terms if he thinks someone else will come along soon and accept them.
- If the market in the sort of property you want is poor at the time you are searching, then you should make sure that there is some sort of a ceiling on the new rent when it is reviewed. You do not want to find you are paying three times as much in three years time.
- Business property leases for longer than three years generally incorporate a provision for the rent to be "reviewed" every three, four, or five years. The review is usually "upwards only". Infrequent reviews obviously lead to your total payment being less over the term of the lease.
- Commercial agents will usually entice you into a deal by setting out only half of the terms which are important to you. Once you have agreed on that basis your solicitor will receive a draft lease document, which gives all of the bad news. By now you are psychologically and practically committed to the property, and you may find your solicitor's concern to be an irritation. Because you think the deal has been done, you think "the legals" are a formality. You will sign anything. You can avoid this trap by making sure your deal with the agent or landlord covers all of the terms that will affect you. If they do not know the answers, ask them to find out and tell you quickly. Get it in writing. You are not paying them! It is far cheaper than paying your solicitor to negotiate. This also saves wasting solicitor's fees if you later decide to withdraw from the deal. You can use a Net Lawman lease document as a model version. The commentary will help you set up your shortlist and tell you what to expect.
- If you take a lease of part of a building, such as a shop in a parade, you will find that some of the terms in the lease may be included for equality and fairness among the tenants. An example might be the division of cost among the tenants for repairs to the roof. It is unlikely that you will be able to negotiate any change on terms of this type. You need to consider in advance what they are before you waste time negotiating inflexible terms.
- Some landlords run a multi-let building or estate on the basis of a "standard" business lease, because they have made special arrangements with a lender to maintain the lender's security by insisting that all units are let on terms which ultimately benefit the lender if the landlord goes bust. Such a lease is often referred to as of "institutional quality". A cynic might say it is the opposite of "tenant quality". A further reason for inflexibility is that the commercial agent now trying to sell you the lease, also "manages" rent collection and repairs and maintenance. They therefore have a strong interest in all the lease obligations being the same, since their job of managing would be more complicated if every tenant had different obligations and rights. One of your questions to the agent at the outset should therefore be as to the flexibility of the lease. If there is no flexibility you should look particularly carefully at the obligations you are being asked to sign.
- Whether you are looking at new built space or not, always use an experienced commercial valuer. He / she will help with:
(i) Rental valuation;
(ii) Negotiating the terms you really want;
(iii) Advising you as to what is or is not possible;
(iv) Preparing a schedule of dilapidations.
- Instruct your surveyor precisely, having negotiated a fixed price. Decide where you want the help and pay only for those services. But beware! Your surveyor too may be reluctant to get involved in the detail he would usually leave to solicitors.
- Despite the forgoing, do not assume that your landlord is trying to take unfair advantage. There may be concessions you can make to the landlord in exchange for concessions that he can make to you. Do not assume that every aspect of the negotiation is contained in the lease.
- Finally, remember that in all matters relating to commercial property, the only rule is "there are no rules". You are simply in a commercial negotiating position.
I know all this. Just take me to where I can choose a document to buy.
Landlords - tips for negotiating the business lease terms
Your first consideration is as to the relative importance of rent, as against capital growth. Whole books have been written on this subject, so space here is limited.
Ø Generally speaking, the market allocates a higher return to property types and locations where the perception of risk is greater. Factors include:
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The chance of tenant default;
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Ease of re-letting if tenant defaults, and time taken to find new tenant;
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Value of property;
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Perception of increase in rental value, which will feed into a higher capital value;
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Acceptability as security for a loan;
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Extent of regular management work;
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Cost of repairs and other expenses;
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Location.
It follows that a multi-let industrial building in poor condition in a Northern industrial area may provide a rent yield of 15% - 20%, whereas a shop on Oxford Street, London may yield only 3%. Of course, the market tends to be risk averse, so you may find that the multi-let building gives you twice or more the net return on the shop.
Ø Negotiate personally, or use an agent you can talk to. For all but the very smallest transactions, you are well advised to use the services of a commercial agent. But if the rent is low, you cannot expect him / her to be trotting out to your distant building every five minutes to see prospect after prospect. For low cost transactions the best person to negotiate the deal is you, the landlord. If your tenant wants an “up-and-over” door or a different shop front, you can arrange the terms, the time and the rent immediately. If it goes through agents, you have lost another month’s rent.
Ø For most transactions, use a commercial agent as an adviser, even if he / she does not show the property. The advice is usually worth far more than the cost.
Ø Start with the terms you want to be included. You might like to use a Net Lawman lease document as a template and aide memoir at an early stage, so that you can be sure to ask your tenant the right questions. The advantage of this is that you may be able to avoid tying up the transaction with solicitors for months while you are receiving no rent. It is far better to negotiate the controversial terms yourself than to leave it to your solicitors to bat draft after draft to and fro. Furthermore, if your new tenant can tell his solicitor that he knows all about whatever points the solicitor raises, the solicitor will be less inclined to be seeking out points to score.
Ø When you have negotiated a deal, make sure all the points you have agreed go out to the other side. Otherwise you will find that one or other of the solicitors is “re-inventing the wheel”.
Ø Put the property into good repair. It is likely to be cheaper for you do so than for your tenant. The property will look better when offered, so will let more easily. You will start from a sound position, so the tenant will have to maintain in better condition. You will not be in breach of any borrowing covenant. Your property will have a greater value. Do we need to say more?
Ø If you want to maximise the value of your property as security for borrowing, make sure your solicitor is aware of this and is a commercial law expert. Small changes to the words of the lease may make a big difference.
Ø If your property is multi-let or the units have common services of any sort, do make sure all the lease provisions are the same. You will create a nightmare if each tenant is allowed to negotiate different terms. Make sure the total obligations add up to 100% of the total cost. This requires separate consideration of each item of expenditure. When you come to offer units to let, you will find acceptance of your “standard” lease if you have considered the tenant’s likely reaction. If your solicitor thinks he is doing you a favour by producing a standard draconian draft, put him right. You want good tenants who pay your rent, not a reputation for machismo and a half empty building.
Ø Business property leases for longer than three years generally incorporate a provision for the rent to be "reviewed" every three, four, or five years. The review is usually "upwards only". Infrequent reviews obviously lead to your total payment being less over the term of the lease.
Always obtain two guarantors for a limited company or one for a new sole trader. Many people operate their business on the basis that if it goes down that is no problem because anything of value is already in the name of wife, husband or mother. The safest guarantors are those most distant from your tenant, so try to avoid spouses and children. Terms in your lease
Why the terms matter
Most business agreements serve two main purposes - first to record the terms agreed and secondly to provide protection to each party against a breach of the terms by the other. Many commercial agreements can be put to the back of the bottom drawer after signing and may never again see the light of day. A business property lease does not come into that category. It is therefore very important that each side is certain that every detail is appropriate and fair. Landlord’s solicitor's costs
Landlords are property professionals. Even quite big tenant businesses rarely employ property professionals. As a result, the balance of property knowledge favors the landlord. Landlords are generally able to dictate terms with very little margin for the tenant to change them. One such term is the provision that the tenant should pay the landlord's solicitor's legal bill. This is an unfair relic from long ago, but many landlords still make it a term of the lease. By far the best way for a tenant to avoid paying the landlord's solicitors is to make quite clear with the landlord or his surveyor agent when the deal is negotiated, that your offer to take the property is subject to your not paying the landlord's solicitor's charges. By doing this the tenant transfers the decision as to whether or not to accept the deal from himself to the landlord. Psychologically a landlord is thus more likely to accept. Because so many tenants do now refuse to pay landlord's solicitor's costs, the landlord is unlikely to feel particularly aggrieved. To him, it is just a question of "some you win, some you lose". Fix your own legal bill
Because leases are long and complicated documents, there is enormous scope for argumentative lawyers to push drafts to and fro over many weeks. Nothing focuses a solicitor's attention on the time taken so much as the proposition that he, and not his client, is paying for it. A fixed price quotation is therefore a splendid incentive to complete your lease efficiently. Heads of terms or lease?
The landlord's solicitor will produce a draft lease. If the transaction is substantial, and particularly if it is a one-off, then he may well start with a "heads of terms" document so that the main commercial elements can be agreed before a draft lease is drawn up. Who sets out the terms
A landlord's solicitor will often present a tenant's solicitor with a draft lease of enormous complexity, accompanied by a terse statement that no amendments will be permitted. This puts the tenant's solicitor in a difficult position. Should he write a 5,000 treatise for his client on all the things that might go wrong if amendments are not made where appropriate, or does he go to a great deal of time and trouble in considering the amendments and drafting them, even though he has been told specifically that none will be accepted? Or does he "take instructions"? Of course, a cynic might say that the tenant’s solicitor will make more money in advising on a complicated lease than on a simple one, so the system gravitates towards unnecessary complication.
Most prospective tenants are not prepared to withdraw from a transaction which has already cost them time and money, and in respect of which they have probably made commercial decisions from which it would be difficult to withdraw. The landlord is perfectly aware of that. However, the landlord is also aware that if there are features of the lease, which may cause serious problems for the tenant, then he will know that the tenant's solicitor will have a professional obligation to recommend to his client that the deal should not go ahead. The result of this power struggle is that the tenant's solicitor is likely to make such amendments as he feels are absolutely minimally necessary, taking his client's instruction not only on the main commercial items in the lease, but on any more obscure legal points where no change has been proposed.
Another excellent way to reduce legal costs, whether you are a landlord or a tenant, is to
consider all of the main commercial elements of a lease in some detail, and agree them
before the details go to solicitors at all. This may mean additional work for the selling
surveyor, but since he is working
on a fixed fee for the landlord, this additional work will cost neither party any money. Power depends on the economic cycle
At different times in the economic cycle the landlord or the tenant may have the upper hand. When times are booming and everybody wants new premises, a landlord will be far less likely to accept substantial amendments to his draft lease than when times are bad and he is desperate to obtain the letting. Tenants also often fail to appreciate that a landlord may want to either borrow against the "investment" created by the tenant's occupation, or alternatively to sell it. The landlord is therefore concerned to maximise the commercial value of the lease. There are many provisions in a lease which may not put the tenant at serious risk, but which do improve the commercial value of the property. Thus, when a landlord's solicitor insists on terms, which help him create an "institutional quality" lease, the tenant should realise that he has some bargaining power.
Here are some of the terms you might see or (as a landlord) wish to include
ü Extent of the property
Agree the plan. Landlords will avoid future problems and arguments if they go to the small expense of obtaining a proper conveyancing plan clearly identifying the areas precisely. Your plan should also show matters referred to in the body of the lease, such as areas designated for parking, access, refuse storage, and the location of underground or overhead cables, pipes, drains and so on.
ü How many years for the lease?
The term of the lease is critically important for both parties. Subject to appropriate rent reviews, the longer the term the greater the value to the landlord. If a landlord wishes to borrow money against the security of the lease, the bank will be unlikely to consider a proposal with a lease of less than five years. A tenant might need a long lease in order to justify high fixed costs or machinery installation, or he may prefer a short lease so that his obligation to pay rent does not hang over him for longer than minimally necessary.
ü Early termination - break clause
A tenant may be able to insist on a "break clause" - that is a provision for the tenant to give notice, at some particular point in time, to terminate the lease then or shortly afterwards. In that way the tenant has the benefit of as long a lease as he chooses, but without the risk that he will want to move on and be stuck with the rent payment. Whether or not a landlord is prepared to accept a break clause depends on the importance of the transaction generally. A landlord presented with a break clause proposal should point out th reduction in the capital value of his property which follows and ask for a higher rent to compensate.
ü Rent
Rent is generally calculated in £s per square foot or £s per square metre. The landlord will often specify a particular round sum when a property is advertised. Like all terms of the lease, the rent is a matter for negotiation. It is very helpful to both parties if the landlord has prepared an accurate scale plan of the interior of the property, from which measurements of the areas can be taken.
ü Rent review
If the lease is for longer than a few years, the landlord should insist on a review to bring the rent into line with rents as they are at that future review date. The less frequent the reviews, the more the tenant benefits by not having to pay the inflationary rise in rent until the review date. Most rent review provisions allow for "upwards only" review. Occasionally this can prejudice a tenant. However, failure to include this provision would reduce the value of the property to the landlord, because a prospective purchaser or lender would not be able to count on the current rent remaining payable beyond the review date.
ü Responsibility for repairs and property maintenance
If the cost of the lease justifies it both sides are strongly recommended to rely on professional surveyors to negotiate repairs terms. If surveyors are not involved, then the landlord and tenant should sit down and make a written list of items with the repairs responsibility marked against each. Without doubt, one of the most fruitful sources of property litigation concerns liability for repairs. A tenant coming into a comparatively new property should understand that the landlord may have little scope for negotiating on the question of repairs, particularly if he is the developer.
Where older buildings are concerned however, it is far more important to the tenant that he is not saddled with an unreasonable liability. An obligation to pay £20,000 for a new roof at the end of a three-year term, at a rent of £5,000 per year, could be quite painful. Both sides should remember the benefit of a "schedule of dilapidations". Jointly appoint a surveyor to provide a list of all the deficiencies in the building. If it can then be agreed that the tenant has no obligation to improve the building beyond the state set out in that list, then both sides have a fair deal.
ü Is the tenant allowed to assign or sub let?
Sub letting is generally out. There are sound legal reasons why a landlord should not permit sub letting. If a proposed lease is to someone whose business requires occupation of smaller parts by others, then he could insist that the tenant uses license agreements rather than sub leases to deal with the downstream occupation.
Assignment is where the tenant transfers the balance of his lease term to someone else. A tenant should understand that a landlord has accepted his package terms knowing the person with whom he is contracting. If the tenant is completely free to assign, then the landlord could find he has given consent to an assignment for someone who fails to pay the rent. The tenant however, really has to be able to part with his interest if he should need to do so. Both sides should therefore consider carefully the extent to which they might need to protect their rights on this question. It is likely to be concluded on the basis that the tenant is allowed to assign, but only subject to safeguards for the landlord.
If the person to whom the tenant assigns fails to pay the rent, the landlord can still come back to
the tenant and ask him for the full rent. When the assignee himself assigns , then the original
tenant is totally free of obligation. |
