Have you ever agreed terms with a landlord to then speak with your solicitor and find out you could have negotiated better? Whilst you may kick yourself, a recent poll showed that prospective tenants generally fail to engage with their commercial property solicitor early enough, leading to unexpected costs and time delays.
All too often the prospective tenant will shake hands with a pushy agent or an experienced landlord to later speak with a lawyer and realise they could have bargained a better position.
Whilst one could speak with the agent and seek to renegotiate, doing so often leads to a breakdown in relations. Remember the agent is usually appointed by the landlord and receives a commission on completion so it’s worth remembering who’s acting in who’s best interest.
The savvy operators will always speak to a lawyer early (often before speaking with the landlord or visiting the property) to ensure any negotiations are strategically considered.
We have highlighted a few tips you may want to consider when negotiating principal terms which will help you to avoid making those all too common and costly mistakes….
Heads of Terms
Usually, after a site viewing and the friendly handshakes, the agent drafts a ‘heads of terms’ document (often referred to as the ‘HoTs’). This details the principal terms and is circulated to the lawyers as the starting point for them to build the legal documentation.
It is therefore critical to ensure these principal terms are negotiated as best as possible from the outset. The document will feature subheadings (we have detailed a few below) and bullet points as to what was agreed.
The terms are largely dictated by the strength of the negotiating parties’ respective position. When negotiating the heads of terms for your shop/office lease or other commercial property – make sure you are able to commit to them and they fit in with your business plan.
Length of Lease
Make sure the length of the lease for your commercial premises is adequate for your business needs. If it is too short you may have to relocate early in the business; potentially affecting goodwill.
Modern day leases are usually not renewable. You may hear or see reference to a lease being ‘excluded from protection of the Landlord and Tenant Act 1954 (the “Act”)’. The Act gives business tenants security of tenure i.e. the right to renew a tenancy when it comes to an end. If the lease is excluded from the benefits of the Act you will have to sign a declaration or swear a statutory declaration depending on when the notice confirming the exclusion is served on you.
If the landlord refuses to allow for the lease to be automatically renewable you may want to consider a longer term particularly if monies are being spent on fitting out or marketing. The goodwill of your business may be affected if you are forced to move location.
Given you may be considering a long term arrangement, you should still hedge your bets and negotiate a break clause.
Consider the usefulness of including a break clause in the lease for your shop/office; for example if you are a new start up business you may need the option of being able to terminate the commercial lease early (i.e. a break clause) if the business is not going as well as you would like it to. Usually, when negotiating a break clause – the landlord will want to insist it is mutual i.e. the landlord can serve notice to break the lease as well as the tenant; you should try and resist this if at all possible. Obviously you do not want the landlord threatening to break the lease if your business is doing well!
When is rent not rent? It may sound like a joke, but it is a serious consideration.
Tenants are frequently surprised when we report to them on the terms of the lease and confirm what the landlord will collect, as rent.
Often there is more payable than just the basic rent – including, building insurance, porterage, utility costs and so on. You should factor in the amount of the business rates and water rates. Also check if the landlord has opted in to charge VAT on the rent. Certain landlords may be obliged to be VAT registered and will then pass these costs on to their tenant; if so this will inflate the rental figure you actually pay in real terms on your shop/office premises.
Does the landlord require you to pay a rent deposit or provide a guarantor? The level of rent deposit may vary but often the request for between 3 and 9 months’ rent deposit is not unusual.
As a rent deposit will tie up a sum of money for the duration of the lease until it is terminated or assigned – every effort should be made to reduce the number of months deposit required.
If a guarantor is required, you may be able to negotiate a release of the guarantor arrangement after 2 or 3 years having demonstrated financial stability.
Leases of terms longer than 3 years normally contain rent review clauses which allow the Landlord to initiate a rent review at set intervals; usually this is an upward only review; so do not expect your rent to go down! How frequently will the rent be reviewed? This depends but the longer the interval between rent reviews the better it is for the tenant as this creates a stable rent environment in
which to grow your business. By way of a general guide, an aggressive landlord may push for a review every 3 years. A savvy tenant will negotiate a rent review every 5 years. Make sure you fully understand the basis on which the rent will be reviewed i.e. is it calculated against open market (i.e. a comparator of other like properties in the area) or linked to retail price index – RPI (i.e. inflation).
Is the user class (i.e. the authorised planning use) of the shop/ office/ property suitable for the needs of your business or will you need to apply for a change of use? For example, a newsagent shop cannot officially be used as a café serving hot food without a change of use. There is no guarantee that any change of use will be granted by the local authority so tread carefully and make your enquiries on this issue before committing to your intended course. Speak to the agent also as the landlord may not agree. To change the user class, an application must be made with the local planning office but beforehand a licence authorising the application must be obtained from the landlord.
Invariably most commercial leases are FRI – full repairing and insuring leases. The wording of the repair provisions can be considerably onerous. The obligation can be as extensive as to “put into repair and then keep it in repair”. Serious consideration should be given to getting a survey of the property in order to understand the potential repairing liability you may be exposing yourself to. You should consider the use of a ‘schedule of condition’. This is a provision attached to the lease with evidence of the condition of the premises when signing the lease, including photographs of the premises as evidence. This alone could save you considerable money when the lease term comes to an end when the landlord seeks to recover the costs of repair to the building.
A proficient commercial property solicitor will negotiate an amendment to the repair covenants to limit your liability.
If the property is in disrepair at the outset then this should be factored into the negotiations by either reducing the rent or negotiating a rent free period to get the property up to a reasonable standard. Ensure the costing of any repair work is right as you might find if the rent free period is too short that the equivalent value to you is lost on the costs and time it takes to do the works.
If there is no disrepair; do you need to carry out fit out works or any other alterations required for your business? If so, it is best to get this agreed in principle with the landlord at an early stage as such works normally require the landlord’s consent by a formal licence for works. As you will need to get on with doing the works as soon as you are able to, it is better to get the licence for works agreed at the same time as the lease or agreement for lease.
Rent Free Period
Tenants should always seek to negotiate a rent free period in any event. Whether you are setting up a new business or seeking new premises for your existing business there will usually be a period required to settle in.
If the premises considered are in need of reparatory work, the negotiations for a rent free period should be harder for the landlord to resist. There is no specific formula to calculate a rent free period but you should take into account how long the premises have been vacant, the general state of repair and the marketability of the premises generally. You should be able to apply 1.5 month’s rent free period for each year of the lease, to the first break period as a starting point. . So, for example if you have a 5 year lease with a 3 year break clause, you can seek to start your negotiations from an 8 month rent free period.
Are you responsible for paying the landlord’s costs? You should try and negotiate that each party pays its own costs but may find the landlord will resist this. Again, this largely depends on the strength of the bargaining power of each party.
These are some of the issues that you will need to consider when taking a lease of a shop/office/ other commercial property before you commit yourself to agreeing the to the heads of terms and or the lease.
By consulting your commercial property solicitor at an early stage you will enter the transaction knowing most if not all the risks and benefits, avoid potential difficulties and negotiate much better terms for your business.
For further information on how Saracens can help you call one of our specialist commercial property solicitors and arrange a professional consultation.