Understanding Commercial Leases
Before signing a commercial rental contract, there are a number of things a tenant must understand and consider, which are crucial to minimising their risks and liabilities.
In the interest of clarity, let’s start with the basics. A commercial lease (known more colloquially as a ‘rental contract’) is a legally binding contract between a tenant and a landlord. It grants the tenant the right to use the property for ‘commercial’ activity and for a specific period, in return for money – paid to the landlord. It contains details such as:
- The address of the property
- Date the lease was signed, as well as the beginning and end dates of the rental period; the options for renewing the lease; stipulations which govern rent increases, etc
- Conditions under which the tenant may occupy and use the property
- Details about any deposits - such as upfront security deposit or fees – and conditions for its return
- Who is responsible for repairs and maintenance
- Exit terms - such as dilapidations.
Liabilities, Restriction and Cost Transparency
As a tenant, there are a number of things you must consider before you sign a lease – beyond the rent and service charge costs you will need to pay.
- The lease will dictate when and how you must repair and decorate the premises
- When you can open
- What you can use the premises for
- How you can dispose of the premises
- If you can sub-let all or part of the workspace
- What alterations you can carry out
- If cable and broadband is included in the utilities offer
- Is there sufficient flexibility to leave the premises before the lease end?
For all these reasons, due diligence is a critical ‘must do’ before you sign a lease because you really must know what you can or can not do and be sure you are aware of all potential financial risks – which will allow you to plan and budget more accurately.
This is all about making informed decisions and being absolutely secure in the knowledge that you know what is coming down the track, when it will hit and how much it will cost. Remember, be in control of what you can, because there are bound to be unscheduled expenditures.
Be wise: take professional advice to minimise your risks and liabilities – after all, this is their day job.
Remember, once the lease has been signed, you will not be able to change it without the consent of the landlord – and he/she will only comply with your request if it is in his/her interest to do so, or you are willing to pay a penalty.
These tend to be every three to five years and usually results in an amendment to the amount you pay.
The most common format is an ‘open market rent review’ - the rent is determined by the market conditions at the time of the review. The review could either result in a status quo (the amount you pay remains unchanged), or in an increase – which is determined by the market ‘comparables’.
Be smart: check what local/comparable rents are, but do not just rely on portal prices. Again, a property professional’s local knowledge will prove invaluable. Be sure you know what a ‘reasonable deal’ looks like – consider ‘terms’ as well as the quoted rent and that you have all the intel you need to make an informed decision.
Repairs and insurance
Today, most new leases feature “fully repairing and insuring” clauses (known as FRI leases). This means that it is your responsibility as the tenant to repair and pay for the insurance for the premises. What the repair work entails will be outlined in your lease.
Repair clauses are the most commonly contested aspect of commercial leases, so be wary of any increase in responsibility for you. Be firm in your lease negotiations – or delegate it to someone who does it every day.
Without wanting to belabour the point, make sure the lease length reflects your short and long-term business plans. Your lease should not act as a break on your organisation’s ambitions therefore make sure you are fully cognisant of all liabilities (such as break clauses, assigning or subletting the lease), before you sign on the dotted line.
Many people fall into the trap of thinking that commercial leases can be terminated when the tenant wants to do so – especially if they need to move to smaller or bigger premises.
Remember, even if your lease does have a break clause, the landlord may not want you to terminate the contract
In addition, there may be no break in the tenancy agreement. That is why lease lengths must reflect your business plans goals.
Assignment and subletting
Do not automatically assume that you can assign (transfer or sell) your lease to a new tenant, thereby reducing your liabilities. You might have to enter into an AGA agreement - the outgoing tenant has to guarantee that the new tenant (or "Assignee" of the tenant covenants contained in the lease) meets their obligations.
Even if you are able to transfer the lease, you will be still be responsible for the new tenants and have to ensure they comply with the terms of lease.
Therefore, read through your lease very carefully to ascertain what you can/cannot do, or contact your landlord to find out.
Almost every lease will have clauses which specify the type of activity the tenant can carry out on the premises. If, for example, the lease states you can only use the space as a restaurant then, if you begin selling food online with food items start being collected from the shop, or you turn it into an office space, you may be breaching this clause - which could have financial ramifications.
Finally, consider the energy efficiency rating of the property. Current regulations make it unlawful for landlords to grant a new lease on properties which have an energy performance certificate rating below E. If the property you are considering has a low rating, find out what is planned in order to address this issue.
After 31 March 2023, existing leases on premises rated E or below could result in landlords passing the costs to upgrade the property to tenants, so check the lease to safeguard your interests.
This article might read like a bit of scare mongering but the truth is, your workplace probably represents your organisation’s second or third largest outgoing, so be very careful what you commit to and do, do, do consider seeking the counsel of a property professional.
Not to do so could well prove a false economy, if you do not have the appropriate skills sets in-house.