Changing gear

The capital value of commercial property is generally determined by the rents produced when the property is let. A vacant unit is, at least in the short term, a financial liability for a landlord. He will have to maintain it, pay the business rates to the rating authority and perhaps also pay service charges.  It is therefore critically important to any investor or landlord to ensure that his property remains let and, preferably, occupied.

As a cursory glance in the business pages of the national broadsheets will confirm, from a landlord’s perspective the commercial property market remains weak.  Not a week goes by without pages of advertisements for distressed commercial property sales appearing in professional publications. Major financial institutions are exposed to very substantial commercial property loans, and the proportion of impaired loans remains high.

Over the last two years, capital values of secondary commercial properties have fallen by an average of 45 percent. This fall is a reflection of the weaknesses of tenant demand and presents tenants with an opportunity to renegotiate the terms of their leases, especially if the landlord believes that the alternative is a vacant unit and an insolvent tenant. This tends to be known as “re-gearing”.

Before opening negotiations with your landlord you should be thoroughly familiar with the terms of your lease, and you should then decide what concessions you are really seeking. You should therefore take advice from a chartered surveyor and from a solicitor both of whom are thoroughly conversant with the type of commercial property which you are renting and with the current market practise in such negotiations.

A well advised landlord will require evidence of the tenant’s financial position as a prerequisite to entering into re-gearing negotiations. Common variations to commercial leases include:

- Frequency of rent payment:  Most leases provide for the rent to be paid quarterly in advance. In the current market many landlords will agree monthly advance payments. It is not uncommon for a landlord to require the tenant to pay interest on the deferred element of the foregone quarterly rent payments, respectively for two months and one month, to compensate the landlord for delayed receipt of the quarterly balance otherwise due.

- Rent reviews: This may take the form of a nil review or excluding one or more future reviews.  As a compromise the landlord may possibly agree to abandon an upwards only review and agree an upwards/downwards review.  It is worth making the additional point here that on renewal of a lease with upward only rent reviews within the 1954 Act, it is by no means a foregone conclusion that the Court will refuse a tenant’s proposal for upward/downward reviews.

A competently advised tenant should, as a matter of course, submit such a proposal.

- Shortening the length of the remaining term and thus the duration of the tenant’s continuing liability. Furthermore, extending or reducing the area let:  Although this may have tax consequences.

- Relaxing the provisions relating to assignment, under-letting and sharing occupation. In the case of assignment, the relaxation may also include an absolute release of the outgoing tenant’s continuing liability to the landlord.

- Permitting change of use otherwise prohibited under the lease, but in any event subject to compliance with planning law.

- In conjunction with any, or a combination of any, of the above the variation of a tenant’s break option.  This is a particularly valuable bargaining chip for tenants in the current market.

If you are a tenant it is well worth investigating these possibilities in this currently turbulent market.