The stages involved in letting commercial property can be quite complex for both parties. In particular, taking a lease of a commercial property is a big commitment for a tenant whilst a Landlord will want to protect its asset and rental income stream whilst building and maintaining a good relationship with its tenant.
This article will take you through the stages involved in the letting process and points to consider for both parties from a legal perspective.
Agreeing Heads of terms
Heads of terms setting out the main terms of the agreement between the landlord and tenant will normally be agreed at the outset. Once these have been agreed it is very difficult to change anything later in the process.
Heads of terms should be issued on a subject to contract basis and deal with:
- The extent of the property included in the lease and any additional rights the tenant may need over other property e.g. for parking/loading and unloading of goods
- The tenant’s proposed use of the property
- The amount of rent and whether it will be changed at any time during the lease (known as a rent review or stepped increases during the term)
- The length of the lease
- Any rent free period or incentive for a tenant to take the lease for example, capital contribution towards fit-out costs
- Whether the lease will be protected by the Landlord and Tenant Act 1954
- Any rights to end the lease early (known as break clauses)
- Whether you require any rent deposit from the tenant as security for payment of the rent and compliance with other conditions and the terms on which it will be held
- The tenant’s repairing obligations. These may be limited to a schedule of condition
- Any alterations the tenant may wish to make to the property or signs the tenant want to put up
- Whether the tenant may transfer the lease to a third party or may sublet and whether this will be restricted to subletting of the whole or subletting of part will be permitted
- Whether the tenant will have to pay any of the landlord’s costs e.g. if the tenant withdraws.
Other points to consider at the outset are:
- Any service charge payable by the tenant where the lease is of part of a building or an estate and there are shared facilities which will need to be maintained by the landlord
- Whether VAT is to be payable on the annual rent and any service charge i.e. if the landlord has opted to tax the property
- Insurance provisions in the lease. Generally, the landlord will insure the property and pass the cost onto the tenant. It is usual for the landlord to insure for loss of rent to protect its income for any period where rent is not payable because the premises have been damaged or destroyed by an insured risk. The cost of insurance is normally passed on to the tenant. The tenant will be responsible for insuring its contents and possibly any plate glass at the property.
Disclosing/reviewing information about the property and raising/replying to enquiries
The landlord, via its solicitors, will need to obtain and disclose the property’s title documents to the tenant, checking that the landlord is entitled to grant the lease and whether consents are required from any lender or third party e.g. superior landlord.
The tenant’s solicitor will investigate the property title, checking whether there are any rights, obligations or restrictions affecting the property that may affect the tenant’s proposed use and whether the property benefits from all rights necessary for the tenant’s use.
The tenant’s solicitor may carry out searches against the property and raise any pre-contract enquiries and additional enquiries with the landlord’s solicitor, for example the searches may reveal potential issues which require further clarification.
Agreeing a Schedule of Condition (if required)
The property will be let in its present condition and the tenant will normally become responsible for keeping it in good repair and condition including making good any existing disrepair. This will also include an obligation to repair fixtures and fittings, such as sanitary ware. The tenant may negotiate a limited repairing obligation, particularly if the lease is only for a short period. This is often done by preparing a schedule of current condition of the property which is attached to the lease and the tenant agrees to keep the property in no worse condition than as evidenced in the schedule oft condition. If a landlord agrees to this they might also consider asking the tenant to pay the cost of preparing the schedule and it is advisable for the schedule to contain photographic as well as descriptive evidence. Tenants should also review the schedule to undertand any areas of the property which are not included and would thus be subject to the repair covenant in the lease for example, service media and equipment is usually excluded as it is not tested; the roof may be excluded as a cherry picker may be required which is costly or it may not be easily accessible.
Negotiating and agreeing terms of the lease and any licence for alterations
The lease will be prepared based on the heads of terms. The tenant’s solicitor will review the lease to check it reflects the heads of terms.
If any changes are suggested, these will be negotiated between the parties’ solicitors and sometimes between the parties direct, if necessary.
An agreement for lease may be necessary in certain circumstances, for example, it may be agreed that the landlord will carry out work to the property before the lease is granted or planning permission may need to be obtained. An agreement will ensure that both the landlord and tenant are legally committed to the transaction before further expense is incurred and will also set a date for completion of the lease.
The landlord may wish to limit the works and alterations that the tenant can make to the property and may require it to be a term of the lease that the landlord’s consent will be required before any alterations are made.
If the tenant intends to carry out work to the property, for example, the installation of internal partitions, the erection of signage or installation of aerials and the terms of the lease require the landlord’s consent to be given before the tenant carries out such works, then a licence of alterations will be prepared by the landlord’s solicitor which will impose obligations on the tenant when carrying out the works. A licence for alterations will often require the tenant to reinstate the property when they leave.
The landlord may require a financial deposit from the tenant as security for payment of the rent or complying with any of the lease terms. This will documented by a rent deposit deed setting out when and how the deposit can be used. The money will be the property of the tenant but will generally be held in a separate designated deposit account in the name of the landlord.
Complying with all requirements of the superior landlord to obtain consent (if needed)
If the landlord owns the leasehold interest to the property and there is a superior lease in place, there will usually be provisions in the superior lease requiring the consent of the superior landlord to the grant of any underlease. The superior landlord may have requirements for giving their consent, for example they may require references for the proposed undertenant and certain covenants to be included in the underlease and will need to see and approve the form of underlease.
Complying with the requirements of the Landlord and Tenant Act 1954 (the ‘1954 Act’)
The 1954 Act gives tenants the statutory right to a new lease once the originally agreed term comes to an end. In some circumstances the landlord may not want the tenant to be granted such right, in which case they will serve a1954 Act Notice on the tenant and any guarantor to contract the lease outside of the security of tenure provisions of the 1954 Act. This means that the lease will be excluded from the provisions of the 1954 Act and the tenant will need to make a declaration to confirm its agreement and acknowledge that it will not have a statutory right to renew.
If the landlord’s 1954 Act notice is served on the tenant at least 14 days before the new lease is entered into, the tenant can make a simple declaration which they can sign without it needing to be witnessed by an independent solicitor. If the landlord’s 1954 Act notice is served on the tenant within 14 days before the new lease is entered into, the tenant must make a statutory declaration in front of an independent solicitor.
If there is a guarantor of the new lease, they will also need to make a simple or statutory declaration, as applicable.
Please note that The Law Commission is planning to publish a consultation paper by late 2023 with the intention of modernising the 1954 Act legislation to reflect changes in business practice and the letting market to streamline and simplify the process for the benefit of both landlord and tenant.
Pre completion matters
In good time of completion, the landlord’s solicitor will need to prepare and send to the tenant’s solicitor a completion statement setting out the monies that are owed by the tenant on completion, including any premium, rent payable in advance and any agreed costs, fees and expenses of the landlord that the tenant has agreed to be responsible for on completion, for example solicitor’s or surveyor’s fees.
The tenant will raise a set of standard requisitions of the landlord’s solicitor, to include any required undertakings to be given by the landlord on completion and confirming the completion process that the parties will follow and checking that any lender or third party consent to the grant of the lease is held by the landlord’s solicitor.
Both the landlord and the tenant will need to sign the required documents, including the lease and any supporting documents such as any licences for alterations and rent deposit deeds ahead of completion. The tenant’s solicitor will need to prepare stamp duty land tax forms if applicable in readiness to submit to HMRC within 14 days of completion and will also need to carry out pre-completion searches to check that there have been no new entries registered against the property title at HM Land Registry since the start of the transaction.
Completing the lease
On the agreed completion date, the parties will complete and date the lease. The parties will exchange their signed and dated counterparts of the lease and the tenant’s solicitor will apply to register the lease at the Land Registry, if required, or to register any rights over other property granted by the lease, as well as submitting any stamp duty payable to HMRC.
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