Forewarned is forearmed, and no truer word can be said when it comes to the art of negotiation. And negotiating a commercial lease is no different.
For a tenant, your lease may well one of your biggest assets (and liabilities). So negotiating flexible terms suitable for your business should be a priority. For a landlord, maintaining a degree of control and protecting your interest and value in the premises will be a key consideration.
Many approach the negotiation stage as a competition, but that should not be the case. Negotiations, if conducted properly, are collaborative. There will always be a degree of compromise expected from both sides. After all, this could be the start of a long and fruitful business relationship, so it is essential to get off on the right foot from the start.
However, a tenant should remember that the initial Heads of Terms that it is presented with, will always be stacked in favour of the landlord. A tenant must therefore be prepared to negotiate. Taking early advice if necessary. Once formal Heads of Terms are signed, it is often incredibly difficult to depart from those.
Moreover, the commercial property market is highly influenced by current market conditions. So both parties can leverage those conditions to seek the most desirable terms. We are often asked to act for both landlords and prospective tenants new to the process. Only to realise they have not sought proper advice before putting pen to paper.
Below are our top 5 tips for negotiating a commercial lease:
Entity and Use
A tenant will need to consider early on who will actually hold the lease. You can decide to the take the lease in your personal names or perhaps in the form of a limited company, as an example. Tenants should be mindful of taking leases in their personal capacity as it is the individual(s) who will then be liable and their personal assets are at risk. Taking the lease in the form of a corporate entity can provide certain protection. As it is the company who will be liable under the lease.
For a landlord, you will want to ensure that any corporate tenant can comply with their lease obligations and pay the rent. It is therefore customary for the directors of a newly incorporated company to act as guarantors. Thereby giving the landlord greater recourse should issues arise.
Whichever entity takes the lease, a tenant will want to ensure the lease is suitable for their use. You should therefore familiarise yourself with the planning use classes. And think about whether you might need the lease to allow for greater usage rights, subject to separate planning approval if required.
A longer lease can give greater security for an established tenant, or for particular businesses which require specific premises. Be aware that a longer lease, coupled with a high rent and/or premium can trigger a payment for Stamp Duty Land Tax.
A shorter lease (e.g. 1 to 5 years) can provide a new tenant, or those looking to expand in the near future, a greater degree of flexibility. Although shorter leases do not tend to be as attractive from a marketability perspective when it comes to sell.
In either case a tenant will want to ensure their business lease is protected under the Landlord and Tenant Act 1954. Which gives the tenant a right to automatically renew their lease at the end of the initial term and on a similar basis. A landlord may decide to try and exclude the lease from those provisions. Which means, at lease expiry, the tenant will need to re-negotiate the terms of a new lease. However, if the tenant is well established and financially capable, a landlord may be very pleased to allow the tenant such rights.
Rent free periods and rent deposits
As a landlord, maximising the rental value of a property will be a priority. In a buoyant market you will be less inclined to give tenants a rent free period.
However, where market conditions are tough and there is little interest, a rent free period may provide an incentive to a tenant. It can rescue the property from being left on the market unoccupied and losing rental income.
If a tenant is planning to carry out costly fit-out works to bring the property into repair, or which otherwise improves the look of the property, the tenant could use this as leverage to negotiate a rent free period.
It is often common for a landlord to request a rent deposit from the tenant, which they can draw upon if the rent is not paid. A rent deposit equivalent to 3 or 6 months’ principal rent is a fairly standard request.
As a tenant, however, you should try and negotiate on the release of that deposit. Typically a landlord will want to keep it until the end of the term, which can be significant on a longer lease. However, if you can prove that your turnover is 3 times the annual rent then you should request that the rent deposit be released upon providing proof of the same.
A vital tool in tenants’ armoury is the right to “break” (i.e. terminate) the lease early. This allows a greater degree of flexibility for new businesses. A landlord will want to ensure that the break clause is conditional on certain events. A tenant should not accept onerous conditions to their right to break. For example, so long as the rent has been paid up to date and the property is handed back free of any occupation then the landlord should accept that.
A break clause can also work to a landlords’ advantage. For example, you can agree a mutual break clause, which allows either party to terminate. If you have a particularly difficult tenant then it can provide an earlier escape route.
This is often a bone of contention in lease negotiations as a tenant will want to limit their repairing obligations. Whereas the landlord will want the tenant to assume a greater responsibility for repairs and dilapidations.
A landlord should encourage the tenant to take a “full repairing lease”. With a requirement to put and keep the property into good and substantial repair. This protects the landlords’ reversionary interest in the property, which is a key consideration.
A tenant will want to negotiate limiting their repairing obligations. To ensure that they do not need to put the property (or hand it back) in any better condition than what they found it. This is more prevalent in shorter leases but far less common in longer leases. For the obvious fact that the landlord will not want the property to fall into disrepair.
If the property is in a particularly bad state then there is scope for the tenant to push hard for this. Equally, if the tenant is assuming responsibility for a external repairs then there is an even greater case for this. Coupled with an agreed cap on the service charge perhaps.
Hart Reade Solicitors are a full-service law firm with offices in offices in Eastbourne, Hailsham, Polegate and Meads. We hold a both a Lexcel and Conveyancing Quality Accreditation from the Law Society of England and Wales, as well as being an ALEP member. To make an appointment with one of our business law Solicitors, please phone our office on 01323 727 321.
Alternatively, please complete the contact form below.
Please note, this article does not constitute legal advice and its content may be subject to modification depending on any changes in the law. These are our Top 5 Tips for Negotiating a Commercial Lease.