Lease Structure and Content Flashcards
Net present value
With a freehold or long leasehold (say 999 years) where a premium is paid, it is quite simple to take that premium as the basis of the SDLT or LTT calculation.
It is a little more complex with a short lease with market rent payable. The first step is to calculate a lump sum equivalent of the rent over the years it is payable, called the Net Present Value (NPV).
This calculation uses a complicated formula, but both HM Revenue & Customs and the Welsh Revenue Authority offer an online calculator that can be used. The NPV, once calculated, forms the basis of the SDLT or LTT calculation.
Assessment tip: Do not worry about learning the NPV formula. In the SQE1 you would be given the NPV if asked to calculate the SDLT or LTT, and in practice, most solicitors use the online calculator rather than performing a manual calculation.
What do you need to calculate the NPV?
What do you need to calculate the NPV?
* You will need the start date of the lease, and the lease term (eg, 10 years)
* You will also need the rent payable for each of the first five years
Note: For calculating the NPV and therefore the SDLT or LTT, you must include the rent plus VAT.
The SDLT calculator can be found at https://www.tax.service.gov.uk/calculate-stamp-duty-land-tax/#/intro
The LTT calculator can be found at https://lttcalculator.wra.gov.wales/
Example: A tenant takes a ten year lease of an office at a rent of £200,000 per year plus VAT, with a rent review on the fifth anniversary. Using the online calculator, you would enter £240,000 for each of the first five years. The NPV is £1,995,985.
SDLT on commercial leases
SDLT is assessed on the NPV, and different percentage rates apply to the slices of the total purchase price.
* Up to £150,000, there is no SDLT payable.
* Over £150,000 up to £5 million, SDLT of 1% is payable
* Over £5 million, SDLT of 2% is payable
SDLT is rounded to the nearest pound.
Example: A lease of 10 years with £200,000 plus VAT, rent review at 5 years gives an NPV of £1,995,985.
The first £150,000 is free of SDLT, so it is the remaining £1,995,985 less £150,000 = £1,845,985 that is charged at 1%.
The SDLT payable is £18,459.
LTT on commercial leases
LTT is also assessed on the NPV, and different percentage rates apply to the slices of the total purchase price. The rates are currently different from SDLT:
* Up to £225,000, there is no LTT payable.
* Over £225,000 up to £2 million, LTT of 1% is payable
* Over £2 million, LTT of 2% is payable
Unlike SDLT, LTT is not rounded to the nearest pound.
Example: A lease of 10 years with £200,000 plus VAT, rent review at 5 years gives an NPV of £1,995,985.
The first £225,000 is free of LTT, so it is the remaining £1,995,985 less £225,000 = £1,770,985 that is charged at 1%.
The SDLT payable is £17,709.85.
Registration of leases
Unlike freeholds, not all leases need to be registered. Leases are treated differently depending upon the length of term granted.
Term of lease up to 3 years – does not need to be registered. Cannot be noted against the landlord’s title.
Term of lease more than 3 years up to 7 years - does not need to be registered. Can be noted against the landlord’s title (it will appear in the schedule of leases to the landlord’s freehold title).
Term of lease more than 7 years - must be registered at the Land Registry (and will be given its own title number). Will be noted against the landlord’s title (it will appear in the schedule of leases to the landlord’s freehold title).
Procedure for registering lease
If a lease is registrable, then an OS1 (lease of whole) or OS2 (lease of part) search should have been carried out before completion to give priority.
The tenant applies to register the lease using form AP1 (if the landlord’s title is registered) or FR1 (if the landlord’s title is unregistered).
A certified copy of the lease may be scanned and submitted electronically.
If the landlord’s freehold title is charged, then a letter of consent from the lender will also be needed.
On completion of the application, the tenant’s solicitor will receive two official copies (the new leasehold title and the updated landlord’s title)
Note that if the tenant is a company, then usually the lease will not be charged, and so there is no need to register the transaction at Companies House.
Alterations
Alterations are changes to the premises, such as reconfiguring the internal walls, opening up new windows, adding a mezzanine floor, etc.
If the lease is silent on alterations, then the tenant is free to carry out alterations. The only restriction imposed by law is the doctrine of “waste” which means that the tenant cannot carry out alterations which reduce the value of the premises.
In practice, an institutional landlord will want to control tenant’s alterations to avoid issues such as the premises being less appealing to other future tenants.
Restrictions on alterations
Typical provisions in an FRI lease:
* The type of alterations permitted (external or internal, structural or non-structural?)
* If they are permitted, whether landlord’s consent needed
* Whether they must be reinstated (ie, the premises returned to its original state) at the end of the lease term
The degree of control will likely depend on the type of alteration. For example, in an office lease, it is common to allow internal non-structural partitions to be altered to provide a different office configuration.
Covenant
Absolute covenant
An absolute covenant against alterations means that they are not permitted.
If the tenant wants to make an alteration covered by an absolute covenant, they can ask the landlord, but the landlord has no obligation even to consider such a request.
Qualified covenant
A qualified covenant against alterations means that they are only permitted with landlord’s consent. The landlord does not have to give consent.
A fully qualified covenant is similar to a qualified covenant, but in this case, the landlord must act reasonably in deciding to withhold consent.
The same lease may have a mixture of absolute, qualified and fully qualified covenants for different matters. For example, it might have an absolute covenant against external and structural alterations, a qualified covenant against internal non-structural alterations, and no covenant against alterations to internal partitioning. This terminology is not restricted to alterations – you will see it in relation to other covenants.
Improvements
If the lease contains a qualified covenant against alterations, s19(2) LTA1927 converts it to a fully qualified covenant insofar as the tenant’s proposed alterations are improvements from the point of view of the tenant.
The conversion from qualified to fully qualified covenant
It will be rare that a tenant will propose alterations that do not constitute an improvement from their point of view (otherwise why would they want them?).
Note that you will come across other areas where there is interplay between the drafting of a lease and statute.
Unfortunately, it is not consistent, and you need to know different rules for different provisions.
Licence for alterations
If the landlord consents to alterations under a qualified covenant, then the consent will usually be documented in a licence for alterations.
As well as details of the works consented to, and any time limit for carrying them out, it will contain various tenant’s covenants as below:
· carry out the works in compliance with the landlord’s requirements, typically with good quality materials and a high standard of workmanship
· pay the landlord’s costs in dealing with the tenant’s application for a licence for alterations (these will usually be the surveyor’s and solicitor’s costs)
· obtain all necessary consents, which could include planning permissions and building regulations approval
· reinstate the premises at the end of the lease term (ie, put them back in their original state without the alterations and put right any damage caused)
Tenant’s statutory right to carry out improvements
If the tenant’s proposed alterations are improvements, then even if the lease contains an absolute covenant against alterations, the tenant may be able to circumvent this.
* Under s3, LTA1927, the tenant serves notice on the landlord of its intention to carry out improvements.
* If the landlord objects, the tenant can apply for the court’s permission to carry out the improvements. The court will give permission if the improvements:
* add to the letting value of the property;
* are reasonable and suitable to the character of the property; and
* will not diminish the value of any other property belonging to the landlord.
* If the landlord does not object within three months, the tenant may go ahead and carry out the improvements.
* The landlord may offer to carry out the works itself and increase the rent, but the tenant does not have to agree to this. However, the tenant can then not ask the court for permission.
User
User refers to what the lease allows the tenant to use the premises for.
If the lease were to be silent on user, then the tenant is free to use the premises for anything they like. The lease will therefore control the use of the premises with a user clause.
The user may be very specific (“as a tailor’s shop”) or more general (“as retail premises”) or may be by reference to the appropriate use class (“as a use within Class E(a) of the Town and Country Planning (Use Classes) Order 1987”).
Generally, the tenant will want a more general use to allow them flexibility, and to make the lease more appealing if they want to pass the lease on.
Conversely, the landlord may wish to keep the user very narrow. However this can backfire on the landlord, as it limits the appeal of the premises. This could limit the market rent on rent review.
Change of use
As with alterations, the lease may prohibit changes of user (an absolute covenant), allow changes of user with consent (qualified covenant) or allow changes of user with consent not to be unreasonably withheld (fully qualified covenant).
Note that unlike a qualified alterations covenant (regarding tenant’s improvements), statute does not convert a qualified user clause to a fully qualified user clause.
However, section 19(3) of the Landlord and Tenant Act 1927 does mean that if the landlord decides to give consent to a change of use, the landlord may not charge a lump sum or increase the rent for giving consent unless the change of use also requires structural alterations (in which case the landlord may charge a lump sum or increase the rent for giving consent).
Assessment tip: Make sure you understand how statute affects qualified covenants of different types. It is less generous to the tenant for changes of use than for alterations. You do not need to know, however, the statutory references.
Planning law for alterations and changes of use
Remember that alterations may involve building works, and a change of use may take the property outside the use class for which it has planning permission.
The lease will usually contain a clause requiring that the tenant complies with relevant laws (and this obligation will usually be restated in the licence for alterations or licence to change use).
Accordingly, to comply with the lease and to ensure that it does not face enforcement action, the tenant must ensure they have the relevant consents.
Code for Leasing Business Premises
The Code sets out some points of good practice on alterations and change of use such as the following:
* The lease should only restrict alterations and change of use insofar as necessary to protect the value of the premises and any adjoining or neighbouring premises of the landlord.
* The Code (subject to certain exceptions) requires a landlord to at least give the tenant a fully qualified covenant for internal non-structural alterations in a lease of part, and the tenant the ability to carry out internal non-structural alterations without consent in a lease of whole.
* If the landlord will require any alterations to be reinstated at the end of the lease, this should be made clear in the heads of terms. Otherwise, the lease may only require this if it is reasonable.
