Five errors tenants make when negotiating leases
John Banbury Lease Consultancy
Tenants often make mistakes when negotiating leases. Leases are complex legal documents requiring specialist attention but, often, proper thought is not given to the consequences of lease clauses until later down the line when their effect kicks in.
A lack of forethought can leave tenants in complicated disputes over lease renewal – disputes that could have been avoided.
So, what are the most common oversights made by tenants when negotiating a lease?
1. Tenants are unwilling to pay extra to secure a lease inside the Landlord and Tenant Act 1954
Between 1939 and 1945, thousands of bombs were dropped on London and other UK cities. More than 70,000 buildings in the capital were destroyed and a further 1.7m damaged, making them unsuitable for immediate occupation. The resulting property shortage gave landlords the advantage. Many threatened not to renew leases for long-standing tenants unless they paid a premium. Tenants were faced with having to pay up or navigate the cost and uncertainty of moving.
The Landlord and Tenant Act 1954 protects tenants from eviction at the end of the term of their lease: the act requires that landlords give one of seven legitimate reasons for not renewing the lease, such as redevelopment.
The Act still has important applications today. For example, pre-Brexit stockpiling and online retailing has led to a shortage of warehouse space. A company renting industrial space is in a precarious position if its lease falls outside the Landlord and Tenant Act 1954. Should its landlord opt not to renew its lease, the company is faced with finding new space – of which there is worryingly little available.
2. Accepting a short hypothetical term in the rent review
Many tenants heedlessly agree to a short hypothetical term even when they have agreed a long lease. Rent review clauses are rarely negotiated thoughtfully and landlords will often slip in a short hypothetical term, which is typically valued more highly than a longer one.
But, the terms of the review clause are subject to negotiation when the lease is being drafted, and it is in the tenant’s best interest to request the longest term possible.
3. Getting caught out by post-break rent free periods
Landlords often offer a rent-free period to keep the headline rent high, which is used to boost the value of their investment – a good bargain to entice new tenants.
However, it is important for tenants to be clear on how the rent-free period is treated during a rent review. For example, a ten-year lease often has a break clause in year five, but with, say, a six months rent free period if they do not use it. At the same time there is often a rent review at year five and if the review clause is not properly worded, tenants can end up with a skewed rent-review valuation that negates the rent-free period by forcing the rent higher.
4. Agreeing to conditional break clauses
A break clause gives either the landlord or tenant the right to end a lease early.
The conditions of a break clause are strictly interpreted by the courts and can easily be misconstrued by tenants: innocuous phrases like ‘comply with the covenants of the lease’ may allow a break to be frustrated by something as small as a broken window blind.
Non-compliance with the break conditions can render a break ineffective, so a tenant may be liable for another five years of the lease, having already moved out. To avoid misinterpretation of the break clause, tenants should refer to a lease-consultancy surveyor when the lease is drafted.
5. Not having both a lawyer and a surveyor review a lease
Tenants will benefit significantly from using both a lawyer and a surveyor to review a draft lease. A lawyer looks at the legal interpretation of a lease clause while a surveyor looks at the valuation impact of that clause.
For example, during the famous headline-rent court case, Broadgate Square vs. Lehman Brothers, the landlord’s lawyers argued that the wording of the lease allowed them to review the rent to the headline rent, ignoring the effect of any rent free period. The landlord won the case. But, five years later at the next rent review, the case went before a surveyor acting as an arbitrator. This surveyor agreed that the words purported to a headline rent, but also saw the valuation impact: that any tenant taking on a lease with such an onerous rent-review clause would want a discount. The discount was decided to be equivalent to the benefit that the lawyers secured in the first court case – nullifying their victory.
The moral of this story is, when drafting leases, request input from both a lawyer and lease consultancy expert. Each have different expertise, so the lease is looked at from all angles and any issues are ironed out.