When times are good and the bull market is in full flow, landlords often have the upper hand when signing up new tenants. But when times are less prosperous and the bear shows its teeth, tenants are often in a better position to renegotiate.
Around 90 per cent of UK commercial property is tenant occupied with approximately 60 per cent of landlords comprising institutional investors.
Larger investors differ somewhat to their smaller counterparts in that the capital value of their portfolio is often used as collateral for additional borrowing rather than predominantly being motivated by rental income.
When a property lease is approaching its expiry, the capital value of the investment diminishes due to risk and uncertainty of the projected income stream. Once the lease has been renewed and a longer term has been secured, the capital value then increases.
This cycle in the leasing process often highlights potential opportunities for tenants to renegotiate more favourable terms when approaching their lease expiry and to share in the added value that their tenancy creates.
We always advise our clients to commence the renewal process at least 18 months prior to their lease expiry or break option in order to leave sufficient time to achieve the best possible outcome.
In the current economic climate, the renewal process should be considered even sooner, as landlords are now often willing to renegotiate lease terms up to 24 months pre-expiry.”
A landlord’s willingness to renew a tenant’s lease early stems from the rise in capital value associated with securing a longer income stream and in addition, avoiding the prospect of being left with a vacant property and its liabilities. In return, a tenant has the opportunity to renegotiate its own terms which could include the following:
Removing tenants’ break options
It’s common for leases to have “one-off” break options built into the lease.
For example, many 10-year leases have a break option after five years which the tenant can elect to operate and vacate the premises.
If a tenant is happy in the premises and isn’t considering a move, it’s still worth contacting the landlord to see what incentives (such as a rent-free period) are on offer for a tenant remaining in the property and not relocating.
The negotiating strength of the tenant will reflect the availability of vacant units in the area, the type of landlord and the cost of the tenant’s fit-out in their existing premises.
For a number of reasons, landlords have traditionally resisted granting rent reductions when renewing or renegotiating a tenant’s lease.
One way of overcoming this issue is to negotiate an appropriate period whereby the rent payable is either temporarily reduced or waived altogether. Utilising this strategy can potentially translate into substantial cash savings.
Reduced repairing liabilities
Under the terms of most commercial leases, the tenant is obliged to keep the property in good repair and therefore potentially gives rise to a substantial liability at lease expiry.
Addressing this point at the time of negotiation can provide the tenant an opportunity to reduce their liability and in turn offer an additional level of cost certainty.
For example, a tenant could agree with the landlord to place a limit on their repairing obligations by agreeing to maintain the building in no better condition than the decoration itemised in a Schedule of Condition.
Over recent years average lease lengths have fallen as occupiers have demanded more flexibility, with the result being that most tenants renewing their lease now will be able to achieve shorter lease terms and more frequent break options. The days of the 25 year lease are over!
Other lease terms
There are a number of other lease terms which might be varied in order to provide greater lease flexibility. These might include making changes to the permitted use, the ability to assign and sublet and perhaps even downsizing.
The lease renewal and break option process has always offered a perfect opportunity for the landlord and tenant to engage each other. The fragility of the current economic climate means that there has never been a better time for tenants to exploit their leasing options.
Panikkos Euripides is a commercial lease consultant at Colliers International.
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