Commercial Property FAQs

What are "Heads of Terms" and what do they typically include?

A set of Heads of Terms document the principal terms agreed between the parties (i.e. buyer/seller or landlord/tenant) to a transaction.  They will form the basis of the terms set out in detail in a written contract or agreement.  They are usually prepared by agents acting for the parties and only detail the high level terms, such as:

• the agreed price;
• the rent, premium or compensation payable;
• any applicable conditions;
• the position on costs;
• the length of lease term; and
• any bespoke terms that may not apply in every transaction such as confidentiality, break options or planning obligations. 

If you are negotiating heads of terms we always advise to engage your preferred legal advisers early.  This can help ensure that the heads of terms record the agreed principles appropriately for the transaction envisaged.  The clearer the heads of terms are, the less time should be spent negotiating the legal documents, saving both time and expense.

If you require any further advice about Heads of Terms, please contact a member of the Real Estate Team.

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What is a "Service Charge" and how is this calculated?

A Service Charge is a sum paid by a tenant to its landlord for services that the landlord provides and from which the tenant benefits.  The services that the landlord provides will generally relate to a wider estate or building.  As a result, the services provided are usually integral to the operation and use of the building or estate, such as the repair and maintenance of the structure of the building(s), or are essential to provide access to the property, such as maintaining and repairing private common roads as the means of access from the adopted highway to the property.  However, a service charge can also cover additional bespoke services, depending on the set up and services the landlord provides, such as providing a water supply, lighting car parks, or providing bike racks.

Service charges are commonly calculated by reference to the total floor area of the property as a percentage of the total floor area of the estate and/or building.  Alternatively, it could be by reference to a fixed figure subject to annual RPI increases, or simply a fair and reasonable sum determined by the landlord. 

A service charge, like rent, is commonly paid quarterly in advance.  Given the potential for many service charges to fluctuate depending on the actual costs incurred in a service charge year, most service charge provisions allow for an estimated service charge to be charged at the beginning of the service charge year, based on an estimated budget.  This figure is then paid in equal quarterly payments throughout the year, and at the end of each year a service charge reconciliation takes place, with any shortfall payment usually being due on demand and any surplus either refunded or added as a credit to the next year’s estimated service charge.

There may also be provisions dealing with payments into a reserve fund for future large capital payments.

When negotiating heads of terms we advise to consult with your solicitors early.  Depending on the nature of the transaction, it could be possible to agree in the heads important service charge exclusions such as an annual service charge cap.

If you require any further advice about Service Charges, please contact a member of the Real Estate Team.

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What is a Rent Review?

Many leases will contain provisions for the review of the rent during the term.  Most commonly these tend to be an open market review at 5-yearly intervals, or annual RPI increases throughout the term.  It is possible to also have the higher of an open market and an RPI review.  No matter what the calculation for a review, it will almost always be expressed to be an upwards only review (i.e. the rent will never be lower after a review) – although it remains to be seen whether there is a change in the market to this approach following COVID-19.

Rent reviews are very important and can be tricky clauses for both landlords and tenants.  If a rent review has been agreed between the parties, it is important to clearly state the rent review method in the heads of terms.  As solicitors, we can advise on the common pitfalls that can occur in negotiating rent review clauses and assist with drafting to avoid unfair increases.  In addition the assumptions and disregards to be determined at a market review date are important considerations, and we can assist (together with valuation advice from your surveyors) with the drafting to create a fair and balanced position between the parties.

Getting the rent review right is important as it will affect the future investment value of the property for the landlord, and determine the extent of the rental liability for the tenant.

If you require any further advice about Rent Reviews, please contact a member of the Real Estate Team.

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How do I terminate a lease?

There are a number of ways for a lease to come to an end:

1. Expiry of the Term - The contractual term may expire. Note that there may be specific additional requirements which need to be followed if the lease benefits from rights under the Landlord and Tenant Act 1954  (the “1954 Act”).
    
2. Break Clause - The lease may contain a break clause allowing either the landlord or the tenant to terminate the lease at a particular time. Again note that if the lease benefits from rights under the 1954 Act an additional statutory notice may need to be served if the landlord is exercising the break
    
3. Forfeiture - Most leases provide that the landlord can terminate the lease if the tenant does not fulfil its obligations under the lease (e.g. has not paid rent for a specified period, typically between 14 and 21 days, suffers an event of insolvency or has breached other terms of the lease). Termination relating to a tenant’s default is called forfeiture. It should be noted that, in the case of forfeiture for non-payment of rent, a landlord can forfeit the lease without notice. However, for all other breaches, a landlord must first serve a notice on the tenant identifying the breach and giving the tenant a chance to remedy. A tenant may have a right to apply to court for “relief” from forfeiture and ask for the lease to be reinstated if the breach is remedied.
    
4. Surrender - A lease can be terminated early if the landlord and tenant agree to this. This is known as a surrender. It can either be documented in writing, or it can be inferred from the conduct of the landlord and the tenant by "operation of law". If the landlord is happy to take the property back, then a surrender can be a good way to bring the lease to an end.  However if the landlord does not want to take back possession of the property early (for example where the property may take some time to re-let) then it cannot be compelled to do so, although a tenant may offer to pay a premium in an attempt to persuade the landlord to agree to a surrender.

If you require any further advice about terminating a lease, please contact a member of the Real Estate Team.

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What are User Clauses?

Traditionally with commercial leases, a contractual provision within the lease specifies the use (or uses) to which a property may be put and the uses which are prohibited.

A tenant should ensure that the purposes for which it proposes to use the property, as well as any ancillary uses are included in the user clause (e.g. where the main use is as a restaurant, there is likely to be some ancillary storage and office use).

A tenant may also want to ensure that the user cause is not too restrictive so as to prejudice any subsequent decision to assign the lease to a third party, although the landlord may want to keep the user provisions as narrow as possible for estate management purposes.

However, both parties should note that the wording in a user clause can affect the open market rental value of a property on any rent review  under the lease. For example, a lease with a very restrictive user clause could reduce the notional open market rent on a review, whereas a very wide user clause could result in a higher rent payable by the tenant on review.

In addition to the user provisions in the lease, the following should also be checked:

• That there are no restrictive covenants on the landlord’s title preventing particular uses, including the use permitted under the lease.
• That the use is authorised by planning permission. If the use is not authorised, the tenant may face enforcement action. It will not be a defence to enforcement procedures that the lease permits the actual use.
• Other provisions in the lease covering general conduct – for example, many leases contain a general list of prohibited uses, such as no use that breaches load bearing limits in the property.

If you require any further advice about User Clauses, please contact a member of the Real Estate Team.

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What is the Landlord and Tenant Act 1954 and when does it apply?

The Landlord and Tenant Act 1954 (the “1954 Act”) governs the rights and obligations of landlords and tenants of commercial properties. The 1954 Act applies when the following requirements are met: the tenant is occupying the property for business purposes, the property is being occupied by virtue of a lease (as opposed to a licence) and the lease has not been excluded from the 1954 Act.

When the 1954 Act applies, the lease will automatically benefit from security of tenure. This means the tenant will have an automatic right to remain in the property at the end of the lease term , known as “holding over”. The lease will only end if it is brought to an end by the landlord or tenant following one of the methods set out in the 1954 Act. Please see the section on Renewals  for more details.

If the landlord does not want the tenant to have security of tenure then it can specifically exclude the lease from the 1954 Act. This is done by following a strict procedure set out in the Regulatory Reform (Business Tenancies) (England and Wales) Order 2003 (SI 2003/3096) before the lease, or before any agreement for lease, is entered into which includes the landlord serving a notice on the tenant and any guarantor and the tenant and any guarantor completing a simple or statutory declaration to confirm it understands that the lease will not have security of tenure. It is very important this process is followed properly otherwise, regardless of the intention of the parties, the lease will be considered to be within the 1954 Act and have security of tenure. 

In the event that a lease is excluded from the 1954 Act, there is no right for the tenant to be granted a new lease of the property, nor will a statutory tenancy arise to enable the tenant to ‘hold-over’  at the end of the contractual term. However, it does not preclude the landlord and tenant from agreeing terms for a new lease but this will be a commercial negotiation between the parties.

If you require any further advice about the 1954 Act, please contact a member of the Real Estate Team.

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What are the considerations of a lease renewal?

When considering a lease renewal, the first thing to establish is whether the lease has security of tenure. Please see the section on the Landlord and Tenant Act 1954 (the “1954 Act”)  for more details.

Where the lease does not have security of tenure, the lease will end on the date specified in the lease and the tenant must vacate the property by this date. The landlord may be willing to negotiate  a new lease with the tenant before the end of the term but there is no obligation on the landlord to do so.

Where the lease does have security of tenure, the tenant has an automatic right to a lease renewal at the end of the lease term. The landlord or the tenant can initiate the renewal process but if neither party initiates it then the lease will continue on the same terms and this is known as ‘holding over’.

If the landlord initiates the process, they need to serve a Section 25 notice on the tenant between six and twelve months before the lease termination date. This date is the term end date specified in the lease or, if the tenant is holding over, it will be the date specified in the notice which is not less than six months from when the Section 25 notice has been served. The Section 25 notice will either state the reason why the landlord does not wish to grant a new lease or state the landlord’s proposed terms for a new lease. The possible grounds which the landlord can specify if they do not wish to grant a new lease are detailed in the 1954 Act, which include; unpaid arrears of rent, the landlord’s intention to redevelop or take occupation of the property itself amongst others. If the landlord specifies terms for a new lease and the parties cannot agree them, either party may apply to court to decide the terms.  Some of the grounds are discretionary (i.e. the court may grant a new lease even if the grounds are made out), whereas others are mandatory where the court must refuse renewal if the ground is made out.

If the tenant initiates the process, they need to serve a Section 26 notice on the landlord between six and twelve months before the lease termination date. The Section 26 notice will include the tenant’s proposed terms for a new lease. If the parties cannot agree the terms for the new lease, either party may apply to court to decide the terms.

If the landlord receives a Section 26 notice and does not want to offer a new lease then they have a two month period to serve a counter notice on the tenant specifying their grounds for opposition. The possible grounds are the same that they would specify in a Section 25 notice as prescribed in the 1954 Act.

When the tenant does not want to renew their lease, they have two options. Firstly, they can vacate the property by the contractual expiry date in the original lease or secondly, they can serve a Section 27 notice on the landlord giving the landlord at least three months’ notice of their intention to vacate the property provided that such date cannot fall before the expiry date in the original lease. 

The renewal process in the 1954 Act is complicated. There are prescribed forms for the notices and the process must be followed strictly otherwise the parties may find they lose the protections which the 1954 Act affords them.

If you require any further advice about Renewals, please contact a member of the Real Estate Team.

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What type of insurance do I need for my property transaction?

In any property transaction insurance is a hugely important aspect to consider. One of the most important insurances to consider is buildings insurance, whose responsibility it should be, what risks should be covered and what the consequences are should any event happen which is or is not covered by the insurance.

On the sale or purchase of property it is common practice that on exchange ‘risk’ will pass to the buyer.  This has a number of consequences, the principal of which is that the buyer now has a beneficial interest in the property and any damage caused to the property between exchange and completion will be at the buyer’s risk.  As a result it is standard practice for most buyers to insure the property from exchange (even though they are not the legal nor registered owner until completion and registration).  However, there may be circumstances where a departure from these standard principles will be necessary; for example where there is a long period between exchange and completion, or the sale is subject to existing tenancies.  In these circumstances it will be prudent for the seller to continue to insure and hold on trust for the buyer any proceeds of an insurance claim in the event of damage.

In a landlord and tenant situation it will be common for the landlord to insure the property (particularly where the property forms part of a wider estate or building, as the landlord will insure the whole in one block policy).  The tenant will then be required to pay to the landlord its proportion of the insurance premium – such a proportion should be a ‘fair and reasonable’ amount, and is commonly calculated in accordance with the size of the property as a percentage of the total estate.  There may, however, be circumstances where it will be prudent for the tenant to insure the property (notably when a longer lease of whole is granted). 

The lease will also dictate the obligations on each party should damage be caused to the property.  Here it is imperative the provisions are clear.  Where the landlord insures and the reason for the damage is covered by the insurance, they should be under an obligation to reinstate the property, and whilst the reinstatement is taking place the tenant’s rent should be suspended (for at least the period in which the landlord has – or should have – in place loss of rent insurance).  Whether or not a break clause is included in the event the property is not reinstated within a certain time frame is appropriate will depend on the circumstances. In a long lease with nominal rent this may not be appropriate, or if it is included, the tenant should take a share not only in the insurance proceeds but also the market value of the property is held on trust for the tenant. 

It is also commonplace nowadays for market rent leases to include provisions dealing with ‘uninsured risks’.  This covers situations where insurance was unavailable in the insurance market.  Without such provisions this means the property may be damaged through no fault of the tenant, and there are no insurance proceeds for the landlord to reinstate (again at no fault of the landlord).  In such circumstances it is again common to provide for suspension of rents and reinstatement (if the landlord is able), or termination where it is impossible.

In addition to buildings insurance there are also a wide number of other insurances that you may want to consider during a property transaction such as:

• Loss of rent insurance;
• Title indemnity insurance;
• Third party liability insurance;
• Contractors’ Insurance;
• Professional Indemnity Insurance;

Whilst as solicitors we are not financial advisers and are not regulated to advise on the products themselves we are able to discuss the in general terms risks and benefits of having or not having such policies, and when they may or may not be appropriate.

If you require any further advice about Insurance, please contact a member of the Real Estate Team.

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What is the Stamp Duty Land Tax on new leases?

Stamp Duty Land Tax (“SDLT”) is payable on certain land transactions, including the grant of a new lease or the purchase of a new property. The tenant of a new lease and a buyer of a new property is said to receive a “chargeable interest” and is liable to pay any SDLT due.  SDLT is a scale charge against the premium and/or rents payable.  If VAT  is also applied the SDLT charge is to the premium and/or rent including any VAT element.

In the majority of cases, the tenant or buyer must also ensure that they submit an SDLT Return within 14 days after the effective date of the grant of the lease or completion of the purchase (even where an exemption applies). Failure to do so will result in penalties and interest becoming due.

Where the landlord and tenant have entered into an agreement for Lease or a seller and buyer have entered into a contract for sale, the tenant/buyer must also be wary as “substantial performance” of the agreement before completion as this triggers the requirement to pay SDLT.  Generally, substantial performance will require either:

1. the taking possession of the whole or substantially the whole of the property prior to completion; or
2. the payment of a substantial amount of the consideration prior to completion.

Therefore, in the context of a lease transaction, if the tenant takes occupation prior to completion to commence its fit out works, this is considered by HMRC as substantial performance and thus triggers the liability for SDLT prior to the completion of the lease.  Substantial performance is contingent on the facts as to whether certain actions (such as site surveys) amount to substantial performance.

If you are considering entering into a new lease or purchasing a new property, it is important to engage your preferred legal adviser early. This will ensure that you:

• know whether SDLT is payable;
• can factor the SDLT liability into your cash flow and business plan; and
• can consider whether any exemptions apply.

If you require any further advice on SDLT, please contact a member of the Real Estate Team.

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What is the VAT on lease payments?

Whether any VAT is due on lease payments (including the payment of a premium or of rent) depends on whether the landlord has exercised an “option to tax” the property.

If an option to tax the property has not been made, the payments under the lease will not be subject to VAT. However, this does not prohibit the landlord from exercising an option to tax the property at a later date.

If an option to tax the property has been made, then VAT will be payable. If potential tenants can recover VAT, then VAT on lease payments is less likely to be an issue as they may recover the VAT paid and the obligation to pay VAT will primarily be a matter of cash flow, although it will increase the amount of Stamp Duty Land Tax payable. A potential tenant who cannot recover VAT should check the VAT status at an early stage as if VAT is payable there could be serious financial implications that they may not have factored into their budget.

It is important to consider the drafting of any lease or agreement for lease, in order to:

• ensure that the lease payments are clearly expressed as inclusive or exclusive of VAT;
• record whether an option to tax has been made; and
• if an option to tax has not been made, to ensure that this position does not change between exchange of the agreement for lease and completion of the lease or once the lease has completed.

Failure to understand the VAT position at the outset can lead to a significant increase in the sums owed under a lease.

If you require any further advice on VAT, please contact a member of the Real Estate Team.

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Who is responsible for Repairs, Reinstatement and Dilapidations?

Pursuant to the terms of the lease a tenant will be responsible for repairing the property demised by the lease (depending on the lease granted this could include the structural elements, or just the ‘internal’ non-structural parts).  The standard of repair (i.e. the condition that the tenant is required to keep the property in) will be set out in the lease.  For example, it may refer to “good and substantial repair and condition” or merely just to keep the property “clean and tidy”.  At the end of the term, the tenant will have to return or “yield up” the property to the landlord in the condition specified by the lease.

A tenant will want to ensure that it is not required to keep or return the property in a better state of repair then it received it.  A tenant may insist on the insertion of a schedule of condition, particularly if the property is in a bad state of repair at the outset, because without such a limit on the scope of the repairing covenant, the tenant could be liable to return the property to a better condition that it received it.

It is common also that a tenant will be required to “reinstate” the property at the end of the lease.  This essentially means to return the property as it found it and would include; removing any alterations that it has made, making good any damage caused by their removal and may include provisions requiring floor coverings to be replaced at the end of the term with new coverings.  Overly onerous reinstatement provisions will be unpalatable to a tenant who has carried out expensive fit out works and (from the landlord’s point of view) may also detrimentally affect any open market rent review .  Landlord’s should consider the reinstatement obligations as it may also be in the landlord’s interest to keep any alterations at the end of the term (for example where such alterations may allow the property to be re-let sooner).     

“Dilapidations” refers to breaches of a tenant’s repairing obligations in the lease.  If a landlord considers that a tenant has not returned the property in the required state of repair, it can bring a dilapidations claim for the costs of remedying this. 

If you require any further advice on Repairs, Reinstatement or Dilapidations, please contact a member of the Real Estate Team.

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Can a tenant make alterations to my property?

This refers to works that a tenant may want to carry out to a property to make it suitable for its requirements. Most leases of commercial property will limit in some way the ability of tenants to carry out alterations.  It is common place for the tenant to be prohibited from carrying out alterations to the structure or exterior of the property (although shop fronts will usually be excluded from this).  Non-structural alterations (such as installing partitioning or non-load bearing walls to form offices), are usually permitted, but often subject to the tenant first obtaining the landlord’s written consent.  The terms of the lease will also require the tenant to cover the landlord’s costs it incurs in granting its consent.

Where the landlord’s consent is required for works, the parties will often need to enter into a licence for alterations.  Under the terms of the licence, the landlord will consent to the works in return for the tenant agreeing to comply with certain obligations (for example, remedying any damage caused to the building during the carrying out of the works, and paying any additional insurance premiums as a result of the works).  The licence will contain full details of the works to be carried out, including plans and specifications.  The tenant may be required to remove these alterations at the end of the term (see “Repairs, Reinstatement and Dilapidations”).

Depending on the extent of the tenant’s initial fit out works, a licence for alterations may be required when the tenant enters into the lease and should be considered early on in the process to ensure that this does not hold up the lease.

If you require any further advice on Alterations, please contact a member of the Real Estate Team.

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What are the steps of a typical new lease transaction?

1. Finding a suitable property
   The first step to securing new property is finding a space that suits your business’s needs and fits within your budget. We recommend that a local agent is instructed, who can assist to tailor you search and provide advice from an early stage.
    

2. Heads of terms
   Once you have found suitable property, the landlord or its agent will issue draft Heads of Terms.

3. Instruct solicitors
   The agreed Heads of Terms will be sent to the appointed solicitors. Your solicitor will send you a letter of engagement and terms of business and will ask for any documents it requires to verify the identity of the client. You should consider obtaining a survey for the property at this stage, as this may highlight issues to be raised by your solicitor.

4. Drafting the lease and preparing a property information pack
   The landlord’s solicitor will prepare the first draft of the lease, which will be based on the Heads of Terms , and will send it to your solicitor. Depending on what has been agreed, the landlord’s solicitor may also provide a draft rent deposit deed , licence for alterations  and/or any other ancillary documents. A pack of property information will also be provided, including title documents, the Energy Performance Certificate (“EPC”) and replies to Commercial Property Standard Enquiries (“CPSE’s”).
    
5. Document review and due diligence
   Your solicitor will review and where necessary amend the draft documents so that they reflect the Heads of Terms and your instructions. Your solicitor will also review the property information he or she has received, including any property searches that have been obtained and may raise enquiries of the landlord’s solicitor to obtain further information.
    
6. Reporting
   Your solicitor will prepare a report (often referred to as a ‘Report on Title’) once it has completed its due diligence and the documents have been agreed. The report will contain a summary of the key terms and legal consideration that you should be aware of before completing the lease.

7. Completion and post-completion
   Once you and the landlord have signed the lease and any other documents, the lease will be dated (i.e. completed). Your solicitor will tell you where you can collect the keys, fobs etc... from. After completion, your solicitor will deal with any post-completion formalities such as registering the lease at HM Land Registry and paying any Stamp Duty Land Tax.

If you require any further advice on the steps involved in a new lease transaction, please contact a member of the Real Estate Team.

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What are the main costs involved in taking a new commercial lease?