Things to consider for a Tenant when negotiating heads of terms of a commercial lease
Have you found a home for your business and decided to lease a commercial space?
The next step will be to negotiate Heads of Terms. This process can be new and tricky for many Tenants. It is common for a Tenant to negotiate the terms without the benefit of professional advice which may later hinder negotiations over the finer details of the lease.
Most leases are open to negotiation, and this is an important task which should be fulfilled by each Tenant before signing off on the Heads of Terms.
The below are tips for you as a Tenant to consider when negotiating lease terms:
- Consider the term duration.
It is essential that you consider whether a long-term lease or short-term lease is a better option for you. This would depend on your individual circumstances. If you have a well-established business and expect to continue trading for many years in the future, then you may wish to ensure that your business can be tied into the property for a reasonably long period.
Short-term leases usually offer more flexibility and may be better for Tenants just starting their business. On the other hand, short-terms leases may mean higher rents and lack of security and stability. For example, if your business has become established by the time that your lease term comes to an end, it will be very much in your Landlord’s hands as to whether the lease will be renewed (and upon what terms). It is fair to say that the Landlord is likely to be aware that you may be more likely to agree to pay an increased rent rather than incur the expense and disruption of moving to alternative premises.
One option that best serves a new tenant owning a fledgling business would be to agree a longer-term lease (say, five years) but with the option to determine (or “break”) the lease after an agreed period (usually at the end of the second or third year). In this way, if the business does not meet the level of success required then the lease can be brought to end by exercising the break option, but if the business performs well then the lease will simply run its full term.
You might also wish to exercise the break option if your business grew rather more quickly than expected (thus requiring new and larger premises).
A commercial Landlord may also seek the right to ‘break’ the lease early, and which may be justifiable in certain cases. The Landlord may also agree to the inclusion of a break clause only on condition that it is mutual. In either case, this may be a disadvantage for your business.
Break clauses are often open to interpretation and therefore it is essential for the provisions to be checked by a solicitor.
- Understand the risk of ‘contracting out the Landlord and Tenant Act 1954 protections.’
The general rule is that business leases are protected, and the tenancy will not automatically end when the term of the lease expires, and you will have a right to be granted a renewal lease (which can be opposed by the landlord only on certain grounds). This is known as security of tenure.
So what does ‘contracting out’ mean? If you agree with the Landlord that the lease would be ‘contracted out’, the lease will not be protected, and you will have no right to stay in the premises at the end of the term. You may have no right to compensation from the landlord.
‘Contracting out’ gives the Landlord flexibility and generally reflect the fact the short term leases generally have a negative affect upon the value of a freehold (when compared to long term leases) and Landlords do not therefore wish to find themselves subject to a short term lease that can be renewed by the Tenant at will at the end of each term.Contracting out may also be appropriate if the Landlord intends to develop or sell the property at the end of the term.
- Know how much you have to pay
By determining how much you pay per month and how much your rent may increase you can better determine budgets. Even shorter-term leases can provide for the rent to be reviewed after, say, two or three years to reflect any increases in market rents generally.VAT may be chargeable is some cases – and if your business is not VAT registered than you will not be able to reclaim the VAT paid.Most leases require the Tenant to pay towards the cost of insuring the premises.Some leases include extra payments such as utilities etc. or may require Tenants to contribute towards the costs of maintaining the common parts (or even of the fabric of the whole building). You do not want to be stuck with unexpected costs. Make sure that you ascertain the total cost that will be involved and that the total cost fits your budget. It is recommended to appoint a surveyor or agent to advise you on appropriate rent.
If there are to be delays and cost incurred whilst you carry out fitting-out work, repairs or other works to enable you to operate from the premises then you might ask for a rent-free period. A Landlord may agree to a rent-free period especially when the commercial space has been vacant for a while.
- Will you be able to operate your business to its fullest capacity?
Can you legally use the property for your business? Does your lease include parking spaces and rights to open spaces such as a garden?
It is essential to check these matters. You can only use the leased property for purposes stated in the lease (agreed by the Landlord).
- Know who is responsible for repairs on the property.
Be aware of a full repairing and insuring lease! A full repairing and insuring lease means that you will be responsible for all repairs. If you are taking a lease of the whole of a property, you will be responsible for the full extent of the property including roof and foundations. This can quickly tally up to large costs. It is recommended for a tenant to arrange for a survey to be undertaken in such cases. This may reveal any costly future repairs. You may then be able to negotiate with the Landlord that the Landlord or both of you would undertake alterations or renovation of the property before occupation.
It is obviously better that you do not agree to accept any repairing obligations other than to keep the interior of the premises in good repair and decorative condition.
If you obliged to accept a full repairing obligation then you should seek to limit your obligation and ask for a covenant to keep the premises only in the state of repair and condition than it was at the start of the lease. In this case a schedule of conditions should be prepared and annexed to the lease.
If you wish to lease a part of a building, the general rule is that the Landlord will be responsible for the structure of the building or common parts, but it is possible you will be obliged to contribute towards the costs. We refer to this as a full repairing obligation “through the back door” and the warnings above will apply to the same extent.
- Completion and Post-completion costs.
If your lease is 7 years or longer, it will have to be registered at HM Land Registry. Stamp Duty Land Tax (“SDLT”) can be payable on business leases depending upon the length of the term and the rent payable. A Tenant is responsible for all aspects of SDLT. The calculation of SDLT is not a straightforward process and involves a complex formula.
Sometimes the Landlord may seek agreement that the Tenant pays the Landlord’s costs for granting the lease.This was quite usual many years ago, but is a practice that cannot be justified in the present day.
- Seek legal advice.
A commercial lease is a legally binding agreement between you and the Landlord. It is legally binding when is reviewed, agreed upon and signed. Always seek legal advice to ensure your best interests are protected. It is important to make sure that you get the best deal for you and your business.
The above list is not exhaustive list of points to consider when negotiating a commercial lease. There are many other aspects that you need to consider. It is recommended that you check written Heads of Terms after negotiations take place to ensure that all negotiated terms are correct. Be aware that once a lease has been signed and registered at HM Land Registry, any changes to it can be made by a deed of variation. This process can be lengthy and additional cost would be involved.
Gareth Richards
James Gass