Seven fatal mistakes for commercial property leaseholders

Property & Construction | Reports

Written by Panikkos Euripides MRICS, Director of Windsor Grange

After 13 years negotiating hundreds of business lease deals, I’ve seen the good, the bad and the ugly. Poor operational property decisions can often lead to some very expensive outcomes and in some cases the demise of the business altogether. In this summary, I set out the top seven mistakes that I see time and again, and which I am often needing to unravel. They say that prevention is better than cure.

Seven fatal mistakes

Should you have a schedule of condition when taking a dilapidated space?

Dilapidation? What’s that? Well, it can be a great big bill. A commercial lease will typically contain a provision for the tenant to keep the property in good repair and condition, throughout the lease term and also how it is to be left at the end. That’s why foreign investors love UK property so much. The tenant pays for everything. When taking on a new space, whilst ideally, it would be fit for purpose and in good condition, the reality is that often you will take space that needs some work and in many cases, is severely dilapidated.

So, why would a landlord put this kind of space on the market and why would you even consider it? Well it costs a landlord time and money and hassle to organise and manage these works, so of course it’s easier to let the incoming tenant do it. The tenant may have a good vision of how they want the space to look, in line with their company image. We do this all the time. For example, I hate buying a house that’s already been refurbished, as I’m paying for somebody else’s taste, so instead I purchase a run down property, buy at a good price and refurbish to my own liking. I’ve done this several times.

What a tenant often neglects to consider, is what the repairing obligations of the lease spell out and whether this effectively means that they will need to put the property back to a similar condition or at least layout as original or often in better condition than they have fitted out to. It’s a tricky one, but if you are taking on space that is not Grade A ready, ensure that you have a good quality schedule of condition drawn up and have it attached and referenced to the lease that both parties will sign.

Unauthorised improvements

Business tenants often carry out improvement works to their property either at the beginning or during the lease term itself. This could include fitting out, adding physical space, structural alterations and adding air-conditioning to name just a few. Often, they do not seek the necessary formal authorisation from their landlord in line with the terms of their lease.

The potential outcome means that either the tenant could be asked to reinstate to the original condition, which is often impractical and too costly, or they can end up paying additional rent and often held to ransom, having to pay a hefty premium for the benefit of the works.

It is wise to always obtain formal landlord’s consent for any proposed changes prior to spending any money or at least consult a surveyor to advise on what is necessary. The only exception to this rule is in the case of minor alterations that do not require landlord’s consent and that do not add rentable value.

A lease is a fixed contract that cannot be changed

A lease is a fixed contractual agreement between two parties. However, at the end of the day, a contract can be torn up at any time, provided both parties are agreeable. At the end of the day we are all human and what might have seemed a good idea at the time of signing may not be fit for purpose later down the line.

‘Codswallop’ I hear you say. Well, I can tell you that for the last seven years of my 13 year career, a huge proportion of my work has entailed renegotiating contracts to suit both parties’ changing needs. I’m not saying it’s easy and I’m not saying it’s possible in every situation, but if you can find a mutual benefit, a ‘win/win’ scenario, then it can work very well indeed.

Never assume you are tied to a contract and try not to bury your head in the sand. It is always worth exploring a more viable solution before writing off a liability and committing resources unnecessarily.

An undocumented Rent Review

Most leases of longer than five years will typically contain a provision to review the rent at regular intervals. These are there to safeguard the landlord against inflation and ensure that rents are kept in line with market trends over a sustained period of time. A rent review is effectively a fixed valuation date and in 99% of all commercial leases, there is a clause that states that the rent cannot be reduced.

So, let’s say that a few years into your lease, the landlord triggers a rent review, proposing to increase your rent by 20%. You write back to disagree with him, setting out your case for why you feel such an increase is not justified at this time. The landlord goes quiet, and you never hear anything more about it. You feel relieved and a little proud that you’ve managed to save some much needed cash.

Several years later, you receive a further letter, this time from the landlord’s surveyor, advising that the next rent review is due and that the rent should increase by 50%, oh, and that the previous rent review is also being triggered again and the increase on that is 30%. Hold on, is this possible? Well, yes, it is. Unless a rent review is properly documented and recorded, usually by way of a signed Rent Review Memoranda, it is still open for review, to include back dated rent and interest at the prescribed rate!

I see this scenario time and again and this is an oversight that can have serious implications, especially when you are at the tail end of a long lease. Could your business afford a sudden increase in rent or indeed a backdated rent payment of tens of thousands of pounds?

Always ensure that you formally document a rent review, even if the rent does not change. If the review is not ‘triggered’ by the landlord, the tenant usually has provision to proactively initiate the process.

Missed break clause dates – Easily done and painful to endure

One or more break clauses can be inserted into a lease agreement, in favour of the tenant, or the landlord or both. They can also be conditional on various factors. For example, a landlord’s break can be subject to proof of intended redevelopment. For tenants, a break clause is used to provide flexibility to accommodate a potential change in future circumstances. This is more prevalent for businesses that have relatively low entry/exit ‘costs, however many high cost businesses also feel more at ease if they are not tied down.

Now imagine you take a 10 year lease and have a break clause at the end of year five, you’ve got five months left to go until the break date. You’ve been reviewing your options and have decided the property just isn’t working for the business and is a cash drain. You make a call to your solicitor to trigger the break clause only to be advised that you have missed your deadline because you were required to give a minimum notice period and comply with a number of conditions. You’re now stuck with a property that doesn’t work for you for a further 5 years with all the associated liabilities!

Or how about this one, you serve your break notice in good time, do what you think you need to do to comply, find alternative premises, spend hundreds of thousands relocating all your equipment and staff, then get a letter advising you that you did not in fact comply with terms of the break clause and I am afraid you are again stuck with the property until the next available exit point. To top it all, you’re not even utilising the space so you now need to try and assign the lease, sublet or have it sitting empty.

Plan at least 12 months before the break date and at least 6 months before the break ‘trigger notice date’. Always take professional advice and never try and trigger the break yourself.

Negotiating – It’s easy, isn’t it?

Let’s be honest, we all believe we are superstar negotiators. Does this scenario sound familiar? You get your car insurance renewal quote, you phone up and threaten to leave. They give you a small discount to keep you happy and loyal. You feel like you’ve done a great job. Which you have, but let’s not get carried away.

A Commercial Lease is a different kettle of fish. Consider this, would you have a loved one go in for an operation and then half way through ask the surgeon if you could have a go at tinkering because you’ve watched a few episodes of ER? I didn’t think so. We may not be talking about heart surgery, but we could be talking about a lot of money being lost or indeed left on the table.

Commercial leases contain many clauses and whilst the principle behind them can be straight forward, the specific way in which they are worded can have huge implications, especially when taking into account wider market conditions. In summary, it is always prudent to have an expert advise you on such specialist matters. They will save you time, money and mitigate your risk over the short, medium and long term.

Renewal rights – don’t take these for granted and don’t just assume that you have them! 

Probably one of the most contentious lease terms is the tenant’s ability to renew their lease. Under business tenancy law, all business tenancies have renewal rights. But – and it’s a big but – both parties can, and often do, ‘contract out’ of this protection. Meaning that in many leases, there will be no rights to remain in occupation beyond the lease expiry date. If you do, then technically you are trespassing.

In addition, even if you have renewal rights, these are limited as the landlord may still take back possession if he claims on one or more of the seven pre-stipulated grounds. Some of these grounds include intended redevelopment and taking back for the purpose of the landlord’s own occupation.

So, why would a sane business person agree to take a lease without renewal rights? Simple really. It’s a lack of choice. If you’re seeking a suitable business premises and the most desirable option comes with perfect foot fall, size, specification but it doesn’t have renewal rights, you may decide that it’s a risk you’re willing to take compared to another property that doesn’t tick as many boxes. Or simply, the specific location you are looking to operate in just doesn’t have the supply of premises with the option of having renewal rights. It may, therefore, be a business risk you are willing to take.

Until fairly recently, it was quite rare for landlords to grant leases without renewal rights. However, it would seem that since the last recession, particularly in London, more and more landlords have insisted that the incoming tenant ‘contract out’ of their renewal rights. This is sometimes because of genuine planned redevelopment, but often, simply to gain more leverage over the renewal process. As a result, the landlord gains a significant advantage as they can hold the tenant to ransom by imposing a higher -often considerably higher- than market rent and can dictate other key terms such as lease length and other restrictions.

It is always advisable to ensure that you have renewal rights where possible and where not, at least to understand the risks and mitigate accordingly. I have lost count of the number of times where a tenant’s business has effectively become worthless through lack of planning and ineffective negotiation.

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