How to negotiate a commercial lease

There are always two sides to a coin and it is no different when a landlord and tenant negotiate a commercial lease. Both parties to the lease are trying to get the best deal possible, and that is why it is important to understand the key points to negotiate. Seeking legal advice from a commercial property solicitor at an early stage will assist you in being able to focus on the points that matter and the steps to achieve this.

This article by Harry Lee, Solicitor in our Commercial Property department, considers some of the essential elements in a commercial lease and the approach you might take in the negotiation, depending on whether you are landlord or tenant.

The rent

This will be the starting point from which future rent reviews will be carried out. The rent is normally set at what the landlord can best expect for the property. Of course, the landlord will want as much as possible by way of rent whilst the tenant is likely to argue for a lower sum.

To achieve a fair rent, there are a number of factors to take into consideration. The tenant should check the rental values of other similar properties in the locality and compare these to the property they are attempting to lease. It is often easiest to break this down to rent per square foot and then compare this to similar properties in the same locality.

From a landlord’s perspective, irrespective of the rent being paid in the locality, there may be an argument that the property is unique or that rental property may be scarce in that particular location. This tends to lead to a higher rent being demanded by the landlord.

There is also the question of the “strength of the covenant” being offered and applies to both sides. What is meant by this is the confidence of the landlord that the rent will be paid and that the tenant will comply with all conditions contained in the lease. However, where the tenant is a start-up or does not have a solid trading history, the landlord might ask for a higher rental or a rental deposit from the tenant to secure the lease and protect against potential early termination.

Rent reviews

As a tenant you should check when rent reviews will take place and what triggers these. Does the landlord need to give notice of its intention to increase the rent, or does it happen automatically?

The tenant also needs to think about the basis for the review. The rent review may be tied to an index such as the Retail Price Index or depend on the rent for comparable premises on the open market value.

Both parties need to ensure that the rent review mechanism is clear, workable and what happens next if they are unable to agree to the increased rent.

Rent deposit

In some instances, the landlord might insist on a rent deposit if they believe the tenant does not have adequate trading history or are concerned about the tenant’s financial standing. If the landlord suggests this, the tenant should ask that this be time limited so that the rent can be returned after the tenant has proved their ability to pay the rent and comply with the lease obligations.

Personal guarantees

In addition to, or in place of a rent deposit, the landlord might insist on a personal guarantee. This is common when the tenant is a limited company, especially a newly formed limited company, or where the tenant’s trading accounts are not strong.

The common recommendation is that personal guarantees should be avoided as it means the landlord can come directly to the individual if the tenant defaults on any condition contained in the lease. This can lead to the landlord taking proceedings against the person who has given the guarantee.

The duration or term of the lease

The duration or term of the lease is another essential term in negotiations. From a landlord’s perspective, the aim might be to look for as long a term as possible if the tenant is of good quality. From a tenant’s perspective, the aim might be to look for a shorter lease incorporating a break and extension options to allow them flexibility in the future should it find the location or facilities in the premises become unsuitable or if they outgrow the premises and need to move elsewhere to larger premises.

Break and Extension Clauses

Either party may seek to have break or extension clauses inserted into the lease. This may improve the flexibility of the lease. The parties will need to agree who can trigger the break or extension options, how much notice must be given and if there are any conditions that must be met first.

Break and extension options might also trigger a rent review or attract payment of a premium, usually by the tenant to the landlord.

Rent-free period

Invariably, works will be required to the premises which the tenant needs to carry out in advance of, or as they are commencing trading. This means it is not unusual for a tenant to seek a rent-free period.

From a landlord’s perspective, it may be an attractive proposition to allow the tenant a rent-free period as the works or improvements proposed by the tenant might enhance the value of the premises.

As far as the length of the rent-free period is concerned, it will depend on market demand for the type of premises, the condition of the premises prior to commencement of the lease and what the tenant is seeking to do.

Repair obligations

The lease should be clear on who is responsible for which elements of repair and maintenance. This is important because if the tenant is responsible for repair and maintenance of the premises, the landlord can visit to inspect and, if the premises are not up to the standard required in the lease, serve a dilapidations notice requiring the tenant to make good any damage (See our article on dilapidations here for further information on this area).

If the obligations for repair and maintenance are placed on the tenant, it is often useful to prepare a Schedule of Condition of the premises at the start of the lease. This will enable the tenant to exclude any damage existing at the commencement date from the repairing obligations in the lease.

Alterations clause

If the tenant wants alterations made to the premises prior to the commencement date of the lease, the landlord might be amenable to carrying these out. This may either be at the tenant’s cost,  or at their own cost, should they believe that the alterations will secure the lease and/or if the alterations improve the capital value of the premises or enhance its marketability in the future.

The tenant should review the provision in the lease relating to alterations it might wish to carry out during the term of the lease. Check the notice requirements and what information the landlord needs in order to grant consent.

It is particularly important to review any reinstatement conditions which might mean that the premises need to be restored to the pre-alterations condition on termination of the lease.

Subletting clause

If the tenant intends to sublet all or part of the premises, make sure the lease allows this. Check what the lease says about any notice you need to give to the landlord and what information the landlord might need to give consent to this.

From a landlord’s perspective, there is always the risk that the tenant might disappear, leaving them with a sub-tenant occupying the premises. This can be problematic, especially as there is no direct relationship between the landlord and the sub-tenant. The landlord should insist on provisions that allow them to step into the tenant’s shoes in a sub-letting situation in the event that the tenant fails to pay the rent or otherwise fails to comply with the terms and conditions in the lease.

Termination of the lease

The termination date of the lease should be clearly stated. In addition, if the landlord has the ability to terminate the lease before that date, it is important to check the provisions that allow the landlord to do so.

Landlords and tenants should take legal advice

One of the key elements when negotiating a commercial lease is to take legal advice. This is an essential requirement. The lawyer will explain the technical conditions in the lease and their implications for the tenant.

The landlord should also seek legal advice to ensure the lease is created in a form that ensures any breach can be enforceable against the tenant and that any rent or other sums due under the lease can be quickly recovered.

If you would like any more information relating to this article please contact Harry Lee on 020 8221 8012 or at harry.lee@bowlinglaw.co.uk

This article is not intended to provide legal advice; it is intended to provide information of general interest about current legal issues.