Whether you are a Landlord letting your commercial premises or a Tenant signing a new Lease you need to be aware of key lease terms that may have an impact on the rental value. These are as follows:-
A lease is granted for a set period of time which is referred to as the Term. Commercial Leases are usually granted for a “fixed term” which means the Lease will start and end on the fixed dates specified in the Lease. The Lease may, however, provide for either party to terminate the Lease at an earlier date; this right is referred to as a Break Right.
Both Lease Term and Break Right have an important impact on the rental value. For instance, shorter leases tend to attract higher rent compared to longer lease terms. Interestingly, if the premises require a high fit out capital expenditure (such as some restaurant premises), longer lease terms may be more preferential for the Tenant, with shorter leases attracting a discount.
With regard to the Break Right, Tenant only Break tend to increase the rental value, while Landlord only Breaks tend to attract a discount due to a reduced term certainty for the Tenant.
Rent Review Pattern
The Lease usually provides for the rent to be increased during the Term. There may be set dates within the Lease for the rent to be reviewed. The Lease will set out the procedure for the rent review. The rent may be reviewed to the market rate, in which case the reviews will usually take place every 3 to 5 years. Alternatively, the rent may be reviewed by reference to an index (usually the Retail Price Index (RPI)) or by reference to the open market valuation and if so, the review will commonly take place more frequently than every 5 years.
Rent Review clause may impact your rental value where more frequent rent review pattern may attract a discount to the initial rent agreed.
The Lease will usually impose repairing obligations on the Tenant. In some situations, the Lease may also impose repairing obligations on the Landlord. The Tenant may be required to “keep” the property in repair, which means that the Tenant must put the property into a good state of repair, even if it was not in a good state of repair at the date of the Lease. Alternatively, the Tenant may be required to repair the property in accordance with a schedule of condition, which will be attached to the Lease, which is a less onerous repairing obligation.
The general rule is that the more repairing obligations the Tenant has – the higher is the discount on the rental value. In addition, onerous repairing obligations may also attract a discount.
Alterations and Improvements
The Lease may impose certain restrictions on the alterations and improvements the Tenant is entitled to make. Such provisions are included within a Lease to protect the Landlord from alterations which could damage the Landlord’s investment interest in the property. The Lease would usually also provide for the property to be reinstated to its original configuration before the end of the term.
The standard Alterations Clause allows non-structural alterations (with landlords consent not to be unreasonably withheld or delayed), while structural alterations are prohibited. Absolute restriction on non-structural repairs may attract a discount to the rent agreed.
Assignment and Underletting
A Tenant may want to sell its interest in the Lease; this sale is referred to as an Assignment. A Tenant may want to keep its interest in the Lease but allow someone else to use part of the whole of the property by way of an underlease; this is referred to as an Underletting. However, there are likely to be a number of the restrictions associated with the assignment and underletting of the property which need to be considered in detail at the outset.
Most leases provide that the Landlord’s consent will need to be obtained before the grant of an assignment or an underlease. The Tenant must ensure that such a consent is obtained prior to granting an assignment or underlease.
Some leases may have absolute restriction on assignment. This restriction may have a strong impact on the rental value of the property and typically attracts a discount as the Tenant will not be able to assign the lease if they choose to relocate or close their business.
Generally, a Lease will expressly set out how the property may be used which will usually be defined as the Permitted Use. The Lease will either express the permitted use positively i.e. “the Tenant shall use the property for [a permitted use]” or negatively i.e. “the Tenant shall not use the property otherwise than for [the permitted use]”.
Some leases may have the use or the property restricted to Tenant’s business only (for instance a barber shop). This reduces Tenants options when it comes to lease assignment and therefore may attract a discount to a market rent.
Contracting Out of the Landlord & Tenant Act (LTA) 1954
Under the LTA 1954, if a Lease is regarded as a business lease, the Tenant may have certain rights to renew the Lease at the end of the contractual term, or receive compensation from the Landlord for its inability to do so. The Tenant may therefore be required to agree to forgo the rights under the LTA 1954. If so, this would have to be authorised effectively and recorded within the Lease.
If the Lease is “contracted out” of the LTA 1954, the Lease will contain an express clause which confirms that sections 24-28 of the LTA 1954 have been excluded. The Tenant will have no right to renew the Lease and it will terminate at the end of the term at which point the property must be vacated immediately.
If the Lease has not been “contracted out” of the LTA 1954, it will not contain such express provisions and will continue until the Lease has been properly terminated under the LTA 1954, or renewed. Until such point, the Tenant will have the right to remain in the property; this period of time is usually referred to as the “holding over” period.
Despite the growing number of leases being contracted outside the LTA 1954, this may still attract a discount to the rental value for your commercial property due to reduced terms certainty for the tenant.