Rent & Term Overview
Overview
Generally, commercial lease terms are much longer than residential property leases and letting agreements and place more responsibilities on tenants. There are no detailed regulations equivalent to those that apply to residential tenancies.
Most longer commercial leases are structured so as to place the full repairing and insuring obligations on the tenant. In the case of shorter lettings (generally less than 5 years), the landlord is likely to have more obligations such as for certain repairs, insurance and service charges etc.. A letting agreement, tenancy agreement or lease mean much the same thing. The term “lease” is used mainly in relation to longer-term agreements.
“Commercial” leases are effectively investments in non-residential property. It is possible for a landlord and tenant to agree any type of lease terms and conditions they wish, subject to some matters which are regulated. The parties to the original lease sign it and give effect to its terms and conditions. It thereby becomes legally binding between them and their respective successors as landlord and tenant.
The terms and conditions of the particular lease are critical to the strength of the investment. There is no standard form of lease. However, the broad terms of leases of similar types of property and for similar lengths of time usually contain similar key terms. However, every lease is negotiable and its contents may reflect the era when it was entered, the relative bargaining strength and the quality of the advice to the parties when it was entered.
The form of longer commercial lease found over the last 25 years is almost invariably an upwards only market rent lease, with five yearly rent reviews. Shorter leases are generally for periods up to five years. Lease terms are a matter for negotiation. In the case of a longer leaser, there is usually a full repairing and insuring responsibility on the tenant. In the case of a multi-unit block the repairing, service charge and insuring costs are paid or reimbursed by the tenant over and above the rent as part of a service charge.
Many commercial property investors retain management agents, who are often firms of auctioneers or surveyors, as agents in relation to the management of the property. A lender may require the assistance of an agent in relation to property management. The agent will play a key part in the negotiation of leases, advising the landlord on the tenant’s applications, repairing and other ongoing obligations. Chartered Surveyors commonly act as fixed charge receivers in the UK.
Rent
Rent is a key commercial term in any lease. In the case of an investment property, the landlord will expect that rent is paid in addition to contributions for service charge and insurance. Rent will usually be payable quarterly in advance, although it is possible to make any commercial arrangement as may be desired. Generally, interest will be due on late rent payments, at a slightly penal rate such as 5% above a base rate.
It is usual and desirable that the tenant is obliged to pay any VAT that arises on the rent. Under the general rules of VAT, the landlord will himself have to account for VAT out of the rent unless the lease specifies that the tenant has to pay VAT on the rent.
Rent deposits are often required as an alternative to or as an addition to a guarantee. It is possible to have rent deposits and guarantees limited in time or limited in amount. If a tenant is commencing business, he may be able to negotiate a clause which provides that once it achieves certain financial targets (e.g. turnover, profits or free cash or distributable cash in excess of a certain number of times the rent), he is entitled to have his guarantor released.
Rent Review
The rent review clause will be critical in longer leases. There is no completely standard form of rent review clause in Ireland. However, most well-drafted clauses are in broadly similar terms. Reviews are commonly programmed to occur at five-year intervals, on an upwards only basis. This means that if on the rent review date, the market rent is less than the current rent, the rent remains at the current rate.
Due to the almost universal existence of upward only rent reviews, the recent 2009 Land Law reforms contain a provision to prohibit upwards only rent reviews. The provision will only become law when a ministerial order is made to commence it. The provision will only apply to new leases made after the provision is commenced.
The standard rent review clause involves resets the rent, based on market value at the review date, if it has increased since the last review date. The most common position is that there are “open market rent” reviews. The parties endeavour to negotiate and agree on the open market rent. If they cannot agree on the market rent, it is referred to an independent valuer or surveyor who will decide the matter either as an expert or an arbitrator.
The property is valued on an open market rent basis on the assumption of a hypothetical new lease between a willing landlord and tenant with no premium. The wording of the rent review clause is critical. In the case of older leases, it may be that the wording has hidden traps for landlord or tenant on rent reviews. This can devalue the investment.
The hypothetical circumstances and assumptions that the valuers must make in setting the new rent are set out in the lease. The valuation is usually undertaken on the basis of the terms of the lease. The effect of this is that the more onerous the lease terms and conditions are, the less attractive they are in the context of a rent review. A restrictive lease is not necessarily in the landlord’s favour.
There are usually a number of assumptions made and a number of matters disregarded in rent reviews. Usually, it is assumed that the property is fully fitted out (unless the tenant has actually done so) and ready for immediate occupation and that the tenant has performed its obligations (so that tenant’s failures of repair etc are disregarded). Tenant’s improvements (which are capital type works over and above those which the tenant is obliged to do under the lease) are commonly disregarded. It is possible for the lease to provide for other assumptions in the valuation. These would be very relevant to the value of the lease as an investment.
It is essential to examine the terms of the lease to ensure that rent review procedures are undertaken in time and are properly conducted. Generally, the time limits for starting rent reviews are not strict. In some older leases, the time limits are strict so that the right to conduct a rent review could be lost in these cases if it is not commenced in time. Invariably the rent review will not start off automatically. There will usually be some form of trigger from the landlord’s or tenant’s side.
No Upward Only Review
A provision in a lease of a premises used for business purposes, granted or agreed after 1st February 2010 which provides for the review of the rent payable under the lease shall be interpreted as providing that the rent payable following such review may be fixed at an amount which is less than, greater than or the same as the amount of rent payable immediately prior to the date on which the rent falls to be reviewed.
This provision applies
- notwithstanding any provision to the contrary contained in the lease or in any agreement for the lease, and
- only as respects that part of the land demised by the lease in which business is permitted to be carried on under the terms of the lease.
This provision applies to a lease of land to be used wholly or partly for the purpose of carrying on a business. It does not apply where the lease concerned, or an agreement for such a lease was entered prior to 1st February 2010.
Term or Duration
The term or duration of a lease is a matter for negotiation between the landlord and tenant and their agent. Because of the ease at which landlord and tenant rights of renewal can now be excluded, the term or duration of the lease is now more commercially significant than before. The term will be important to both landlord and tenant. The tenant will be obliged to quit the premises at the end of the lease unless he negotiates a longer term. The landlord’s right to receive rent will terminate at the end of the lease term unless an extended term is negotiated. The renegotiated new lease will require the consent of landlord and tenant.
The effect of the statutory rights of renewal, detailed in the next chapter, was that a sharp distinction was drawn between leases with a duration or potential duration of more than five years and those with durations of less than five years. If for example, a tenant was in possession, paying rent monthly for three years, then a further three-year lease would mean that he had statutory rights of renewal. These renewal rights could potentially be exercised on successive occasions so that the lease could, in principle, continue indefinitely.
In practice, leases for terms of more than five years, are usually full repairing and insuring lease, with five yearly, upward only, rent reviews. The tenant pays the cost of insurance and service charges and has full repairing responsibility. This is on the basis that the tenant has a long-term interest in the property and that the landlord’s interest is an investment, namely the right to receive the rent.
If a tenant is granted a court lease under its statutory right to a new, it is possible to apply for rent reviews every five years. For this reason, the type of lease granted where a tenant’s right of renewal exists generally provides for five yearly, upward only, rent reviews.
Break options are a matter of agreement. They can allow for either the landlord or tenant to terminate the lease on particular dates. They usually specify dates such as the fifth, tenth anniversary etc. Some are expressed to be personal and can only be exercised by the original tenant.