Chapter 7: Grant of a Relief Flashcards
1 Introduction to leasehold transactions
This section is an introduction to leasehold transactions, and will put them in their commercial context
1.1 Different types of lease
There are different types of lease. For example, it is common to find leases of houses and flats for
long terms, such as 99 or 999 years. With this type of lease, a very low rent is usually payable. For a newer house or flat, it may be, say £150 a year. With older houses it is not uncommon to come across very low rents, such as £2.50 or £5 a year.
1.1 Different types of lease
There are also assured shorthold tenancies, which are common for letting out houses and flats on
a six or twelve month basis. The tenant will pay a market rent for the house or flat. Although
residential conveyancers will become familiar with these types of leases, they are not the primary
focus of this course
Commercial leases are common
Commercial leases are common, and can be for all kinds of different uses. For example, a
commercial lease might relate to an office block, a factory, a warehouse or a shop, whether on
the high street or in a large shopping centre
Relatively short-term
Unlike the residential long lease, a commercial leases is usually for a relatively short term (say, up to 15 years), and a market rent will be payable. In this respect it is similar to an assured shorthold tenancy, but in most other respects it is very different
1.2 Advantages of a lease – tenant’s point of view
From a tenant’s point of view, there are various advantages to taking a lease over buying a
freehold:
* There is no need to spend capital which may be in short supply, especially with a newly
established business, or which may be needed for other purposes.
1.2 Advantages of a lease – tenant’s point of view
- A leasehold is not a permanent investment. If the needs of the business change, the tenant
may have the opportunity to leave the premises at the end of the lease, or in other certain instances. This gives the business flexibility to experiment with taking new or additional premises.
1.2 Advantages of a lease – tenant’s point of view
- Some premises will only be available as a leasehold. For example, if a retail chain want to open a shop in a large shopping centre, they have no choice but to take a lease.
1.3 Who are commercial landlords?
- Private investors, whether individuals or companies, who make a business out of letting
premises. For example, the company Derwent owns a portfolio of 5.5 million square feet of commercial real estate, most of which is in Central London. At the other end of the sale, an
individual may just own one small shop premises and let it out
1.3 Who are commercial landlords?
- Institutional investors. These are financial institutions, typically, pension funds and life assurance companies who invest in property just as they would in the stock market. Compared to the stock market, property has been traditionally seen as a safe and valuable investment, offering both income (through rent) and long term capital growth (through the rise in property prices over time).
1.4 Institutional investors
- Because the institutional investor is concerned with the property in terms of the income it
produces, they favour a full repairing and insuring (FRI) lease. This means that the tenants pick up the costs associated with the property, and the landlord receives the clear rent. We will
look at this in more detail in the appropriate sections.
Covenant Strength
The other issue of concern to an institutional investor is covenant strength. A landlord will want
to know that the tenant has the means to comply with its obligations, and also that it has
assets that the landlord can recover breaches against. A long established company will
generally have good covenant strength, an off-the-shelf new company will not. If the tenant
does not have good covenant strength, the landlord may require a guarantor (such as the
director of the company) or a rent deposit.
1.5 Asset management
A common area of practice for commercial property solicitors is asset management or property
management. This often involves acting for an institutional landlord, and dealing with the legal work generated by the property asset on an ongoing basis. This may involve:
1.5 Asset management
- Granting a lease to a new tenant
- Considering applications by the tenant during the lease; for example, to alter the premises
- Advising on breaches of the lease, such as failure to pay the rent or letting the premises fall
into disrepair - Or dealing with the issues that arise when a lease comes to an end and the tenant is leaving or
wants a new lease.
1.6 Summary
- There are residential and commercial leases, which tend to be quite different. Commercial
leases are the main focus of this course, but many of the principles are transferable. - There are various advantages to a business of taking a lease instead of buying a freehold.
- Most commercial landlords will treat the property primarily as an investment.
1.6 Summary
- Institutional investors are financial institutions, such as pension funds and life assurance
companies. - Asset management involves assisting a commercial landlord (which may be an institutional
investor) with the day to day management of the estate. - This may involve granting new leases, considering applications for consent, advising on breaches of the lease, and dealing with the issues at the end of the lease.
2.1 Lease definition
Woodfall’s Law of Landlord and Tenant defines a lease as:
‘the grant of a right to the exclusive possession of land for a determinate term less than that
which the grantor has himself in the land ’ If the owner has a freehold, their interest is in perpetuity, and therefore it doesn’t matter how long
a fixed term is (10 years, 99 years, 999 years or even more), it will be less than their interest.
2.2 Essential ingredients of a lease
2.2.1 Exclusive possession
Exclusive possession is an essential ingredient of a lease (distinguishing it from a licence). The tenant must be able to exclude strangers and even the landlord (except where the landlord is exercising its right to enter the premises, eg, to inspect it) from the premises let.
2.2.2 Fixed term or periodic tenancy
The lease must be for a fixed term (six months, 5 years, etc) or a periodic term (a weekly tenancy,
monthly tenancy, yearly tenancy etc). Generally speaking, it may not be for an indeterminate time (eg, for as long as the tenant is an
employee of the landlord). There are exceptions.
2.2.3 Formalities
A legal lease must be created by deed if the term is over 3 years. A tenancy of 3 years or under may be created in writing, or even orally.
2.2.3 Formalities
The reversion: The reversion is the interest that the landlord holds subject to the lease. At the
end of the lease term, the property reverts to the landlord.
2.3 What is a lease?
A lease is the document that creates a leasehold interest.
At its simplest it may just state the contractual term and rent payable. There are some common
law and statutory principles that apply to a simple lease. However, in practice, most leases will go
into considerable detail about the respective obligations of the landlord and tenant
2.3 What is a lease?
Drafting and negotiating the terms of a lease is an important part of the work that the landlord’s and tenant’s solicitors undertake. We will look at the landlord’s and tenant’s (and therefore their solicitors’) objectives in negotiating
the terms of the lease.
2.4 Landlord’s objectives
In many cases, the landlord is in the dominant negotiating position. Institutional landlords will insist on a full repairing and insuring (FRI) lease, meaning that any costs are met by the tenant, whether directly or indirectly. This means that rent paid by tenants is
clear of deduction
The landlord will want a lease that ensures the premises are:
- insured
- kept in repair
- only used for the permitted purpose
The landlord will also want:
- to control whom may occupy of the premises (eg, if the tenant tries to pass the lease on)
- to have a say over how the premises are altered by the tenant
- to increase the rent in line with market rent over the contractual term of the lease (by way of
rent review)
2.5 Tenant’s objectives
The tenant will want a lease that:
allows the tenant to use the premises for its intended purpose
has a contractual term (say 10 years) that is satisfactory to the tenant (ie, not too short or too
long for its business purposes)
provides some flexibility if circumstances change
The tenant will not want:
onerous restrictions that prevent the tenant from using the premises for its intended purpose or that make it difficult to pass the lease on to a third party
provisions that allow for a steep rise in rent
excessively unfair provisions (that favour the landlord over the tenant)
2.7 Summary
- A lease grants exclusive possession, is for a determinate term, and if over 3 years, must be
executed by deed - The landlord’s interest (subject to the lease) is the reversion
- An institutional landlord will want an FRI lease
- Most landlords will be in the dominant negotiation
2.7 Summary
- A landlord’s concern is to maximise their investment by ensuring a clear rental stream, and retaining control over the premises
- A tenant’s concern is to be able to use the premises for their intended purpose, and have
flexibility to, for example, pass the premises on if needed
3 Term of a lease, break clauses, rent and rent review
3.1 The lease term
Generally, the lease term must be determinate, meaning that it is either a fixed term (6 months, 5
years, 999 years, etc) or a periodic tenancy (weekly, monthly, yearly, etc). FRI leases are generally for a fixed term, as a lease where the tenant can give notice at any time is not as valuable.
Typical commercial lease terms are 3, 5, 10 or 15 years depending on the business sector.
3.1 The lease term
Shorter and more flexible leases have become more popular in recent years. Reasons might
include:
* Business plans are often drafted in 5 or 10 year cycles. Business tenants may not want to
commit to a property longer than this.
* A tenant may pay less (or even no) Stamp Duty Land Tax or Land Transaction Tax on a shorter
tenancy.
3.2 The term commencement date
Term commencement date: This is the date on which the lease term starts.
The term commencement date
The term commencement date may be the date of completion of the lease (when it is dated and
becomes legally binding), but may also be before or afterwards.
It is common for the term commencement date to be earlier than the lease is dated. A landlord
may want all of the leases to start at the same time for simplicity. Note that if the term started in
the past (whether a week ago or a year ago), the tenant is not generally expected to pay rent for
the period they haven’t used!
Term may start after lease is dated
The term may also start after the lease is dated. This is called a reversionary lease. These may,
for example, be used when the parties want to extend the letting in advance of the expiry of the
current lease.
3.3 Calculating the expiry of a lease term
It is important to understand when the lease term expires. A 10 year term will expire 10 years after the term commencement date, but on what day?
This will depend on how the term is defined in the lease…
3.3.1 Meaning of ‘from and including’
If the term of the lease is ‘from and including’ a certain day of the year, the term expires on the
day before that day of the year in the relevant year (more common in practice). For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23 March 2029
3.3.2 Meaning of ‘from’
If the term of the lease is ‘from and including’ a certain day of the year, the term expires on the day before that day of the year in the relevant year (more common in practice). For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23
March 2029
3.3.2 Meaning of ‘from’
If the term of the lease is ‘from’ a certain day of the year, the term starts the day after that day, and so expires on that day of the year in the relevant year (less common in practice). For example, a lease with a term of 10 years from 24 March 2019 will start on 25 March 2019 and expire on 24 March 2019
3.4 Break clauses
If the tenant is unsure about the commitment of a lease term, and the landlord is unwilling to grant a shorter term, a break clause can be a compromise. Note that if the lease does not include a break clause, in general neither landlord nor tenant can
bring the lease to an end before the end of the fixed term without the agreement of the other.
3.4 Break clauses
A break clause can be a landlord break (meaning only the landlord can exercise it), a tenant break (meaning only the tenant can exercise it – the most common type), or a mutual break
(either party can exercise it). The break clause may specify a date (eg, the fifth anniversary of the term commencement date) or it may be a rolling break (eg, any time after the fifth anniversary of the term commencement date)
Anniversary
Anniversary: This is used in leases to mean the same day of the year. For example, the fifth anniversary of 8 September 2030 would be 8 September 2035.
3.4.1 What’s the difference?
You might wonder why the landlord would accept say, a five year tenant only break clause on a ten year lease, but not a five year term. In either case the tenant can bring the lease to an end at
five years, so what’s the difference?
3.4.1 What’s the difference?
You will be familiar with Internet-based companies who offer a free first month in the hope that you subscribe and forget to cancel. Similarly, landlords will offer a longer lease with a break
clause hoping that the tenant will not use it. Like cancelling Internet subscriptions, exercising a break clause is not easy. A surveyor valuing the landlord’s reversion is likely to consider a 10 year lease with a 5th
anniversary tenant’s break more valuable than a 5 year lease.
3.5 Rent
Most leases fall into one of two categories: either a short lease with a market rent; or a long lease with a ground rent.
3.5.1 Rent in commercial leases
Commercial leases are usually short leases (up to 15 or 20 years) with a market rent (also known as rack rent). A premium (lump sum) is not usually charged on the grant of a commercial lease. For example, a commercial tenant may pay a rent of £20,000 per annum, but will not pay a premium to the landlord on the grant of the lease.
3.5.2 Rent in residential leases
Residential leases may be long leases (say 99 or 999 years) with a ground rent (that may be a low sum, say £150 per annum or even a peppercorn each year). The first person to buy the property will pay a premium (say £200,000) to the landlord for the
grant of the lease. Commercial long leases also exist; for example, land for electrical substations is sometimes leased in this way.
3.6 Rent in a commercial FRI lease
- The rent is usually expressed as a yearly figure (eg, £80,000 per annum) but payable quarterly.
- The year is divided into approximate quarters, which may run from the traditional quarter
days (in bold), based on religious festivals, as follows:
25 December to 24 March
25 March to 23 June
24 June to 28 September
29 September to 24 December - These are still commonly used, but some leases now adopt the modern quarter days being 1 January, 1 April, 1 July and 1 October
3.6 Rent in a commercial FRI lease
- Although the quarters under neither system are the exact same length, the rent is usually divided equally (so if the rent is £80,000 per annum, £20,000 would be payable for each quarter)
- Rent is usually due in advance on the quarter day – for example, on 25 March for the whole
period up to and including 23 June - However, the lease needs to state if the rent is payable in advance (which an FRI lease will) - if the lease is silent, the rent is payable in arrears. This is more often seen in a residential long lease.
3.6 Rent in a commercial FRI lease
- Earlier in this section, we saw that the parties may complete the lease part way through the term. If this is part-way through a quarter, then the quarter will be apportioned, so the tenant
will only pay the appropriate portion of the rent (for example, if the tenant’s lease starts one month into the quarter, they will pay approximately two thirds of that quarter’s rent). - The lease will set out how the rent is to be paid (usually by standing order) and whether VAT is payable on it.
3.6 Rent in a commercial FRI lease
- The lease will usually describe other payments such as contributions to the insurance premium and service charge as ‘rent’. The reason for this is covered in the chapter on termination of leases. The rent proper is often referred to as the ‘annual rent’ or ‘yearly rent’.
3.6.1 Types of rent review
There is no implied right for the landlord to be able to increase the rent. An FRI lease of 10 years or more will usually contain a rent review clause as an institutional investor will want to ensure that their rents are keeping up with the market.
3.6.2 Stepped rent
The lease may set out, for example, a yearly rent of £25,000 for the first two years, a yearly rent of £30,000 for the next two years, and so on…
3.6.3 Turnover rent
The rent may be calculated based on the tenant’s turnover at the property. This is mostly commonly seen with retail leases (eg, shops).
3.6.4 Index-linked rent
The rent is increased by reference to an agreed measure of inflation, such as the retail prices index
3.6.5 Open market rent review
This is the most common type of rent review adopted by FRI leases, and involves ascertaining the rent based on comparable premises and certain principles.