Watch out for hidden costs when leasing premises

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Taking on leased premises is one of the biggest fixed costs a business will face. While headline costs are a major focus, businesses leasing premises need to be aware of the many hidden liabilities when acquiring commercial leased premises, says lawyer Stuart Darlington. Right to break It is well known in the property world that where a tenant has a right to terminate a lease any conditions imposed by the lease must be strictly complied with or the right to terminate is lost. As a result, tenants should resist agreeing any pre-conditions to termination, particularly those that are extremely difficult to comply with. Prime examples include “no breaches of the lease” - there will always be minor breaches no matter how diligent a tenant; or that the tenant must give “vacant possession” by the break date – any failure to strip out fitting out works or even leaving behind a few loose items could count as still being in possession and cost the tenant the right to break. Rent deposits Providing a rent deposit as security is not as simple as it sounds and deposit clauses can seriously affect cash flow. For example, landlords often add VAT to the base amount of security so that in the event of default the deposit it is not 20% short. The problem for tenants is that until there is a default and the landlord draws down, payment of the VAT element is not actually VAT and so the tenant cannot recover the tax in the usual way. Tenants often don’t appreciate that a rent deposit is actually an unlimited liability. This is because rent deposits always contain requirements to pay more into the deposit account to cover any amounts withdrawn by the landlord. At the same time, landlords often insist that if the rent under the lease is increased following a rent review that the deposit is topped up by a corresponding increase. Repair and the end of the lease Any lease obligation to keep the property in repair implies an obligation to first put that property into repair. This means that if a property has any defects or disrepair at day one, the tenant will be liable for bringing the property up to a good state of repair and decoration before they start trading. This could be costly. Therefore, it is strongly advised that tenants arrange a survey that includes the roof, structure and foundations where they are included in the property being let, as any defects here could be extremely expensive. Rent review Leases in excess of five years often include upwards only rent reviews based on the open market value at that time. However, some leases contain increases linked to the increase in the Retail Prices (All Items) Index. The point here to consider is whether the increase is “compounded”. Compounding occurs where the rent is increased in year one by the increase in the index, and then in each subsequent year the rent is further increased by the change in the index since the previous year, and so on. To avoid this, each yearly increase should be calculated using the initial (year one) base rent as the benchmark. Each year that year one rental figure should then be increased by the increase in the index from the month immediately before the start of the lease term to the relevant date of review. That way, increases aren’t applied to already increased rents but the rent is still uplifted in line with RPI. Service charges Few realise that overlooked service charges and rates can often double charges due under the lease. A good example includes any monies paid into a reserve fund. Here a landlord is planning for large or recurring items of expenditure in the future. However, tenants will not get these monies back if they sell the lease or when the lease ends, even where the monies have not been spent. Allied to this are construction and building equipment costs as well as any relevant defects that need fixing. These costs belong to the landlord as the risk of building is theirs. Similarly, any costs that related to getting the premises ready to hand over to tenants should be disbarred. Some service charge provisions contain rights for a landlord to recover the costs of refurbishment of the building. The building is the landlord’s asset and so this should be limited to repairs only. Another area for contention involves the costs of lease renewals, rent reviews, lettings, collection of rents and arrears etc. from other tenants. These are landlord’s own administrative expenses and should not be borne by a tenant. And then there are costs of services from which the tenant does not benefit. These, and costs that relate to unlet parts of the building and common parts they do not use, should not be charged for and nor should the Carbon Reduction Commitment tax as it’s a tax on the landlord’s asset. Tenants should also aim to have all costs payable to any merchants or tenants association included in the service charge cap. This especially applies to marketing and promotion costs which are often charged through the tenants’ association. Likewise, all contributions to reserve funds can sometimes be excluded from the list of service charge costs – they need to be included. Tenants need to be on their guard as landlords are not in the business of framing lease contracts in anything but their own favour. Contracts are onerous and need careful consideration and it is remembering that landlords are essentially looking for profit through rent while as much of their own costs are covered by tenants.   Stuart Darlington is a partner in the real estate team of Michael Simkins LLP.