Commercial landlords have a variety of priorities when it comes to letting property – most of which are focussed on maximising returns. Whilst this makes obvious financial sense, it’s worth being aware of other things to ensure the long term security of your income stream.
In this article we give our top 10 tips for healthy and happy lettings. Where relevant, we have referenced best practice as highlighted in the Code of Leasing Business Premises (Code). Although this Code has been voluntary since it was first introduced in 2007, an updated version is due to be published in 2019. When it is, it is likely to be incorporated into a RICS Professional Statement meaning that surveyors will have to have regard to the Code when preparing Heads of Terms for letting transactions.
Some might argue that avoiding ‘voids’ should be every landlord’s priority. However, experience suggests that a bad tenant costs more in the long run than not having one at all. You need to screen tenants to ensure they will be able to pay the rent, and as a bare minimum comply with the repairing obligations under the lease to ensure your asset is protected. The usual procedure is to take a bank, previous landlord and two trade references where these are available. That won’t always be possible for a brand new business occupier but you can then ‘price’ the risk of letting to a start-up.
Ask for security
To bolster your protection under the lease it is increasingly common to request a guarantor for the tenant. If your tenant will be a company, asking the directors to provide personal guarantees (or perhaps looking for a substantial parent company) to guarantee the company as tenant can help to mitigate the risk for you as landlord. Alternatively where this is not available/feasible then a rent deposit can be requested. As a minimum, three months’ rent is expected but sums in the range of 6-12 months’ worth of rent are a worthwhile ‘hedge’ against non-performance and can provide a more immediate solution than having to take proceedings against a third party guarantor.
Having a tenant lined up and ready to go is worth very little if your own house is not in order. There are an increasing number of regulatory requirements that you as a building owner need to be aware of, even if day to day responsibility will ultimately move across to the tenant once the lease is completed. Compliance with energy performance (including provision of Energy Performance Certificates and the Minimum Energy Efficiency Standards – see the summer 2017 edition of Room with a View), asbestos management and fire safety all need to be considered before a letting is in place to ensure that your property is as attractive as possible to a future tenant.
Rent and rent review
This is the all-important number for any landlord and where professional advice will pay dividends to increase the attractiveness of your property to prospective tenants. But it’s not just the starting rent that should be considered, will there be the opportunity to review the rent, and if so, on what basis? Whilst the majority of rent reviews are to the ‘open market’ value of the property at the date of review, increasingly landlords are looking to alternatives which can provide more certainty (to both sides) of what rental costs will be at a future date. Alternatives include index-linked reviews (tracking either retail or consumer price indexes) or even fixed increases to de-risk the process entirely. Where circumstances (and funders) will allow, being able to offer greater flexibility on rental structures may improve the lettability of your property.
Another function of income – clearly the longer the lease the more secure the rental income. The difficulty that landlords increasingly face is that fewer tenants want to commit to long leases except in limited circumstances (for example where fit-out works will be extensive and/or expensive to carry out). Landlords are now finding other ways to incentivise tenants including options to extend the original lease on favourable terms or giving rent-free periods/holidays where a tenant chooses not to exercise a break clause. This takes us conveniently to break clauses.
With any number of uncertainties in the market, tenants are becoming ever keener to build flexibility into their leases to give them an early ‘out’ if their business circumstances change, for better or worse. Landlords are understandably reluctant to offer termination rights to tenants but by the same token should also be aware of the commercial value of these rights to prospective tenants. Landlords should always assume that a break right will be exercised (and their income stream potentially curtailed) but it is possible to price that risk into the rental value or to offer some other value to the tenant who chooses not to exercise that right, as the potential business disruption to relocating may not justify the expense.
Another area that leads to tensions between landlords and tenants is the question of repairing obligations (and with whom responsibility should lie). Consider factors such as the age of the premises being let and the length of lease the tenant is signing up to. If the property is new or the lease long, then the expectation on the tenant is generally higher, but seeking a full repairing obligation from a tenant taking a short lease of a poor quality building is unrealistic. By the same token be aware of your obligations as landlord of a multi-occupancy building. It is more likely that if a high standard of repair is expected of the tenants then there will be a similar expectation of the landlord in respect of the common and external parts which remain under your control. On the other hand if your tenants are all signed up on short leases you can expect to meet resistance if you try to push major refurbishment works through the service charge arrangements – better little and often to keep the building in a good state rather than allowing repairs to pile up and expecting the tenants to foot a huge bill.
The tenant’s proposed business use must be considered as part of the screening process. While the landlord will not guarantee that the premises are authorised in planning law for the tenant’s proposed use, the use will still impact on the occupational arrangements of the tenant. You also need to control the tenant’s permitted use of the premises so that the tenant doesn’t unilaterally change the business it operates, which is not only undesirable, but can affect the quality of the future rent and repair of the premises, or (if the landlord has other adjoining premises) cause issues or inconvenience to other tenants.
Fit-out works and alterations
Usually the tenant will need to carry out fit-out works to the internal layout of the premises and erect signage to get the premises to reflect their occupational requirements, branding and culture. There may also be some elements of the premises that need improvements and the tenant may be happy to take on those repairs and capital outlay or the landlord may have agreed to do this as part and parcel of the initial letting deal. Either way the landlord needs to ensure the alterations are conducted using good quality materials, in accordance with all necessary statutory consents and can be removed at the end of the term so that the premises can be readily re-let. Equally the tenant is better protected by a written agreement, recording that these works will not be used to increase the rental level payable under the lease, on rent review. It is in both parties’ interest to properly document alterations in the lease, usually through a licence for alterations.
The golden rule
Lastly, the golden rule is to seek and secure professional legal and surveyors’ advice early. Cutting corners at this stage normally leads to more expense further down the line when a problem crops up!
This article is from the winter 2018 issue of Room with a View, our newsletter aimed at professionals within the property industry. To download the latest issue, please visit the newsletter section of our website. Law covered as at January 2019.
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The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at January 2019.