There are many hidden liabilities when acquiring commercial leased premises. Below is a small selection of them to help give you a commercial advantage.
Right to break
If you have a right to terminate a lease, any conditions imposed must be strictly complied with or the right to terminate is lost, leaving you liable to continue to pay the rents and rates for the rest of the lease period (five or 10 years). You should resist agreeing any pre-conditions to termination, particularly those that are extremely difficult to comply with such as:
- There must not be breaches of the lease (there will always be minor breaches no matter how diligent you are), or
- That you must give 'vacant possession' by the break date. Failure to strip out fitting out works or even leaving behind a few loose items could count as still being in possession and cost you the right to break.
There are various hidden costs when providing a rent deposit as security:
- Landlords often add 20 per cent to the deposit amount required so in the event of a default the landlord has not lost the VAT element. However, the payment of that sum into the account is not counted as VAT at that point. You will not get a VAT invoice and cannot recover it in the usual way, which is a cash flow point.
- The interest earned on the deposit is only likely to be nominal and will not be a commercial rate, even if the deposit is large.
- A rent deposit is actually an unlimited liability and not just limited to the initial fixed sum, because of the requirement to pay back into the deposit account any amount withdrawn by the landlord in the event of default.
- Landlords often insist that if the rent is increased upon rent review that the deposit is topped up by a corresponding increase. This is often an unanticipated cash flow point.
Restaurant leases in shopping centres or large landlord schemes often reserve a turnover rent equal to the amount by which a certain percentage of gross turnover exceeds the base rent. It is critical that all tips, gratuities and service charges paid by customers are excluded from the income that counts towards the gross turnover as otherwise this could inflate the turnover rent when you consider some restaurants charge 12.5 to 15 per cent service charge.
Repair and the end of the lease
Leases usually impose liability on you to make good any defects and disrepair even if they existed when you took the lease. Don’t be fooled by a lease that only requires you to keep the premises in repair as the law implies you must first put them in repair. A survey is therefore key. Similarly most leases often require a full strip out of the premises and removal of all fit out when the term of the lease ends. This is often an overlooked expense.
Leases in excess of five years usually include upwards only reviews of the rent to the open market value at that time. Some leases contain yearly increases linked to the increase in the Retail Prices (All Items) Index. This is not all that common in restaurant leases but far more common in leases of public houses. The point to look out for is whether the increase is compounded. This would increase the rent over time far higher than was intended. Compounding is where each year’s increased rent is increased the following year and so on. To avoid this, in each year the base rent in year one should be increased by the increase in the Index since the start of the lease to the relevant year.
Service charges and rates can quite often double the rental liability under the lease and so excluding unreasonable costs is key. Common exclusions are:
- Any advance provisions collected by a landlord for large or recurring items of expenditure in the future. You will not get them back if the lease is sold or ends.
- Costs of original construction of the building and remedying defects in. These should be landlord’s costs as the build risk is theirs.
- Costs of refurbishment of the building of which the premises form part. It is not reasonable for a landlord to be able to recover costs of upgrading its own asset and recovery should be limited to costs of necessary repair.
- Costs of lease renewals, rent reviews, lettings, collection of rents and arrears etc. These are the landlord’s own administrative expenses.
- Management charges exceeding 10 per cent. Any increased percentage a landlord charges for management of the building is unreasonable.
- Costs of services from which the tenant does not benefit, for example a ground floor restaurant should not contribute towards repair and maintenance of the common parts or lifts of offices above.
- Costs of damage which is, or should have been, insured.
- Costs attributable to unlet units in the building. Your service charge should not be increased because other units are empty.
- You should not pay any service charge on any mezzanine floor. Service charges are often apportioned on a floor area basis but it is not reasonable to pay additional service charge because of a mezzanine floor.
- Carbon Reduction Commitment (CRC) costs. Landlords pay a carbon tax on their carbon foot print. This should note be passed on to tenants.
It is even better to negotiate an upper limit or cap on the service charge although there are a number of key points:
- Caps are often increased each year. Each annual date of the increase must be linked to anniversaries of the start of the lease and not the landlord’s service charge accounting dates. Otherwise, this would result in a premature increase in the cap.
- Make sure any increase in the cap is not compounded (see 'rent review' above).
- The cap must be reduced pro rata for any part year during the lease as otherwise in the first and last years the whole year’s cap would apply to those few months.
- All contributions to advance provisions for large or recurring items of expenditure (see above), and contributions to tenants’ associations and promotional costs charged through it should be included in the cap.
The above is not an exhaustive list. For more detailed information you can read the A Tenant’s Practical Guide to Commercial Leases for free here.