Five Key Points for First Time Landlords and Tenants
Considering Commercial Leases – 5 key terms
What is a commercial lease?
Simply put, a commercial lease is a legally binding contract between a landlord and a business tenant giving the tenant the right to use property owned by the landlord for the purpose of it’s business. The contents of most leases are extensive, setting out information regarding the rights and obligations of both landlord and tenant and can have potential substantial financial implications for both parties.
There are many essential elements which both parties need to consider but here are 5 key terms to consider at the outset
- The “Contractual Term” – how long should the Lease be?
The Contractual Term refers to the length of the lease. This brings with it financial implications for both parties.
The tenant needs to consider its commercial objectives and whether the right length of term is being committed to, or whether they need the right to stay on and renew the lease (see below on security of tenure). A tenant may also want the right to end the contractual term early (see below on break clauses). Stamp Duty Land Tax (SDLT) is another important cost for the tenant to consider, as the longer the lease, the more SDLT is potentially payable.
For the landlord, the ideal tenant is one who looks after the property well and stays there for as long as possible, as this could mean a more secure stream of income. But a landlord may also have other future plans for the property which may mean they only want to grant a short lease, or have the benefit of their on break clause as well as having consideration to the position at the end of the term.
- Security of Tenure – what is this?
The Landlord and Tenant Act 1954 (LTA) provides security of tenure for business tenants. Practically, this means that the tenant has the legal right to renew the lease at the end of the contractual term and the Landlord can only refuse in certain circumstances. However, it is often the case that the parties ‘contract out’ of these provisions, which means that the tenant has no right to stay in the premises and must leave at the end of the term (unless otherwise negotiated with the landlord).
Contracting out of the LTA provides greater control to the landlord, allowing them to sell the property with vacant possession or lease it to another tenant on more favourable terms. The strict procedure for “contracting out” must be followed in order to apply. If this procedure is not followed then the tenant will have security of tenure.
A tenant should consider the business impact of a contracted out lease and therefore having no rights to stay in the property beyond the term and therefore having to move an established business.
- Break Clause – do you need one?
A break clause allows the landlord, tenant, or both to end a lease early without facing a penalty and may benefit both parties depending on personal/business circumstance.
Benefits to the tenant include providing flexibility to move out of premises in response to changing business requirements. However, a landlord will often want to add “conditions” to the exercise of a break clause which must be carefully reviewed by a solicitor to avoid getting caught out.
Inclusion of a break clause may also benefit the landlord, providing them with flexibility if they are unsure of their long term plans for the Property.
Conditions to the break can add further protection for the landlord such as ensuring the tenant cannot break the lease early without having paid all rent and other sums due up to date.
- Rent Reviews – what should you consider here?
‘Rent review’ provisions allow for a re-evaluation of the rent at set dates. Review is usually initiated by the landlord and benefits them by ensuring that the rent reflects the true value of the property being let, using either the Retail Prices Index or the rental market as the basis of review. ‘Upwards-only rent reviews’ are a landlord favourite, as this means that rent can only rise or stay the same.
It is important that tenants are aware of the basis on which rent may increase so this is factored into financial planning. A tenant may prefer a shorter term or the benefit of a break clause so that if market rents have decreased they can re-locate and pay a lower rent then they may be subject to following a rent review or of course use a break to exit a lease if a rental increase is going to be prohibitive.
- Repair - what do you need to look out for?
In many commercial leases, the tenant is obliged to bear the costs of all repairs and insurance for the property. In a multi-let building, the tenant will be responsible for the internal repair of their area and the landlord will carry out repairs to the structure and common parts and recover such costs through a service charge. If the tenant is taking a lease of a whole property then it is likely the tenant will be responsible for the repair of the whole building.
In either scenario the condition of the property must be inspected.
A landlord will not want to be out of pocket on dilapidations or repairs to common parts so the repair and service charge clauses are especially important.
As a tenant, it is important to negotiate and if possible limit liability for repair, for example by agreeing only to repair by reference to a Schedule of Condition, or by negotiating a financial cap on service charges. For a tenant, this is often much more difficult to do in a multi-let building where repair and service charge provisions will already have a building standard.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.