Term of a lease, break clauses, rent & rent review

Question 1

Generally, should the lease term be determinate or indeterminate?

Answer 1

Determinate.

Question 2

What is meant by a lease term being determinate?

Answer 2

It is either a fixed term (eg 6 years 5 months), or a periodic tenancy (weekly/monthly).

Question 3

How long are FRI leases, generally?

Answer 3

Generally for a fixed term - as a lease where the tenant can give notice at any time is not as valuable.

Question 4

How long are typical commercial lease terms?

Answer 4

3, 5, 10 or 15 years depending on the business sector.

Question 5

Why have shorter & more flexible leases become more popular in recent years?

Answer 5

• 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_ SDLT or Land Transaction Tax on a shorter tenancy.

Question 6

When is the term commencement date?

Answer 6

The date on which the lease term starts

• may be the date of completion of the lease (when it’s dated and becomes legally binding) , but may also before or afterwards.

Question 7

Is it common for the term commencement date to be earlier than the lease is dated?

Answer 7

Yes - a landlord may want all of the leases to start at the same time for simplicity.

Question 8

If the term started in the past, is the tenant expected to pay rent for the period they haven’t used?

Answer 8

Not generally.

Question 9

What is a reversionary lease?

Answer 9

When the term starts after the lease is dated.

Question 10

When may a revisionary lease be used?

Answer 10

When the parties want to extend the letting in advance of the expiry of the current lease.

Question 11

When will a ten year term expire?

Answer 11

Ten years after the term commencement date - but the day depends on how the term, is defined in the lease.

Question 12

If the term of the lease is ‘from and including’ a certain day of the year - when does the term expire?

Answer 12

The term expires on the day before that day of the year in the relevant year.

example - a lease with a term of 10 years from and including 24 March 2019 expires on 23 March 2029.

Question 13

If the term of the lease is ‘from’ a certain day of the year - when does the term start/expire?

Answer 13

The term starts the day after that day, and expires on that day of the year in the relevant year.

example - a lease with a term of 10 years from 24 March 2019 will start on 25 March 2019 and expire on 24 March 2029.

Question 14

What if the tenant is unsure about the commitment of a lease term & the landlord is unwilling to grant a shorter term?

Answer 14

A break clause can be a compromise.

Question 15

If the lease doesn’t include a break clause, can the landlord/tenant bring the lease to an end before the end of the fixed term without the agreement of the other?

Answer 15

No, generally not.

Question 16

What is meant by a break clause can be a landlord break, a tenant break or a mutual break?

Answer 16

Landlord break - only the landlord can exercise it

Tenant break - only the tenant can exercise it (most common)

Mutual break - either party can exercise it

Question 17

Does the break clause have to specify a date?

Answer 17

No, it may specify a date (eg fifth anniversary of the term commencement date) or it may be a rolling break (eg anytime after the fifth anniversary of the term commencement date).

Question 18

What is meant by anniversary?

Answer 18

This is used in leases to mean the same day of the year - example, the fifth anniversary of 8 Sept 2030 would be 8 Sept 2035.

Question 19

Why do landlords prefer a five year tenant only break clause on a ten year lease over a five year term?

Answer 19

Because, landlords offer a longer lease with a break clause hoping the tenant will not use it - exercising a break clause isn’t easy.

Question 20

What are the two categories that most leases fall into?

Answer 20

1) Short lease with market rent
2) Long lease with ground rent

Question 21

Are commercial leases usually short leases or long leases?

Answer 21

Short leases (up to 15 or 20 years) with a market rent (aka rack rent).

Question 22

Is a premium (lump sum) usually charged on the grant of a commercial lease?

Answer 22

No

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.

Question 23

What are residential leases?

Answer 23

Residential leases may be long leases (99 or 999 years) with a ground rent (that nay be a low sum, eg £150 per annum).

Question 24

Do you have to pay a premium on a property with a residential lease?

Answer 24

Yes - the first person to buy the property will pay a premium (eg. £200,000) to the landlord for the grant of the lease.

Question 25

Is there such thing as commercial long leases?

Answer 25

Yes, for example land for electrical substations is sometimes leased this way.

Question 26

Rent in a commercial FRI lease…

Answer 26

Rent is usually expressed as a yearly figure (eg. £80,000 per annum) but payable quarterly.

Question 27

Rent in a commercial FRI lease - how is the year divided?

Answer 27

Approximate quarters, which may run from the traditional quarter days, based on religious festivals.

Question 28

What are the traditional quarter days?

Answer 28

25 December (to 24 March)
25 March (to 23 June)
24 June (to 28 September)
29 September (to 24 December)

Question 29

Are the traditional quarter days still used?

Answer 29

Yes, but some leases now adopt the modern quarter days being 1 Jan, 1 April, 1 July & 1 October.

Question 30

Since the quarters aren’t all the same length, is the rent divided equally?

Answer 30

Yes

for example - if the rent is £80,000 per annum, £20,000 would be payable for each quarter.

Question 31

Is the rent meant to be paid in advance?

Answer 31

The lease needs to state if the rent is payable in advance (FRI lease will).

Question 32

What if the lease is silent, in terms of rent being paid in advance?

Answer 32

If the lease is silent, the rent is payable in arrears - this is more often seen in a residential long lease.

Question 33

How will the tenant know how the rent is to be paid?

Answer 33

The lease will set out how the rent is to be paid (usually by standing order) & whether VAT is payable on it.

Question 34

Is there an implied right for the landlord to be able to increase the rent?

Answer 34

No
(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).

Question 35

If the lease sets out 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 - what type of rent is this?

Answer 35

Stepped rent.

Question 36

What is turnover rent?

Answer 36

The rent may be calculated based on the tenant’s turnover at the property - mostly commonly seen with retail leases (shops)

Question 37

What type of rent is it where the rent is increased by reference to an agreed measure of inflation, such as the retail prices index?

Answer 37

Index-linked rent.

Question 38

Which type of rent involves ascertaining the rent based on comparable premises and certain principles?

Answer 38

Open market rent review.

Question 39

What is the most common type of rent review adopted by FRI leases?

Answer 39

Open market rent review.

Question 40

What is meant when commercial leases almost always have an ‘upwards only’ rent review?

Answer 40

The rent can only increase.

Question 41

Do open market rent review provisions affect the future rent payable?

Answer 41

Yes.

Question 42

Open market rent review - what if the market rents have fallen on the date of the rent review?

Answer 42

The rent stays the same.

Question 43

Who agrees the new rent after the rent review clauses?

Answer 43

The rent review clauses will give the landlord and tenant the opportunity to agree the new rent between themselves.

Question 44

What if the landlord and tenant can’t agree on the new rent?

Answer 44

The lease will set out a mechanism for a specialist valuer to be engaged to determine the new rent.

Question 45

What will the valuer consider?

Answer 45

1) The rent payable for the comparable premises (premises of similar size & location)

2) the terms of the hypothetical lease - an imaginary lease based on the actual lease but assuming certain matters and disregarding others

Question 46

How is a hypothetical lease different from an actual lease?

Answer 46

From the starting point of the actual lease (and premises) the rent review provisions instruct the valuer on assumptions (matters to assume) and disregards (matters to be disregarded).

Question 47

What are the basic assumptions which enable valuation to take place?

Answer 47

• the premises are vacant & available (as otherwise a prospective tenant wouldn’t be interested)
• there’s a willing landlord and a willing tenant

Question 48

Common disregards…

Answer 48

Disregards generally operate to ignore what the tenant has done voluntarily, and not as an obligation of the lease

• the rationale is that the tenant shouldn’t be penalised with a higher rent if the tenant has improves the premises for its own use.

Question 49

Assumption - the tenant has complied with all its covenants under the lease.
Is it fair?

Answer 49

Yes. If the tenant, sat, lets the premises fall into disrepair, it shouldn’t be rewarded with a lower rent.

Question 50

Assumption - the landlord has complied with all its covenants under the lease.
Is it fair?

Answer 50

No. Say that the lift in an office block never works. This would affect the rent that tenants would pay. From the tenant’s perspective, the assumption is unfair, as the landlord isn’t suffering the consequences of its inaction.

Question 51

Assumption - on the terms of the actual lease other than the rent payable.
Is it fair?

Answer 51

Yes. If the actual lease, for example, has clauses that are very restrictive on the tenant’s use of the property, the tenant is stuck with those and shouldn’t have to pay a higher rent as if those clauses do not exist.

Question 52

Assumption - the term of the hypothetical lease is the term remaining of the actual lease.
Is it fair?

Answer 52

Maybe - can depend on the particular market, and whether prospective tenants favour short or long lease terms.
Say that 5 years are left at rent review, and prospective tenants want 5 year leases. This would work against the tenant who initially took a 10 year lease.

Question 53

Assumption - if damaged or destroyed, the premises have been repaired or rebuilt.
Is this fair?

Answer 53

Yes - because the lease will usually have detailed provisions for what happens in this instance (including suspending the rent). It would be unfair on the landlord if the tenant continues to pay a decreased rent as if the premises have been destroyed once they have been rebuilt.

Question 54

Disregard - the effect of the tenant’s occupation on the rent.
Is it fair?

Answer 54

Yes - the premises will be worth more to the tenant than an new prospective tenant, as the tenant has the convenience of not having to move.

Question 55

Disregard - goodwill attached to the tenant’s business.
Is it fair?

Answer 55

Yes - say the tenant is a restaurant business, If successful, the tenant will make that location more valuable to other restaurant businesses. It’s unfair for the tenant to be penalised with a higher rent for this.

Question 56

Disregard - tenant’s improvements (other than as obliged under the lease)
Is it fair?

Answer 56

Yes - if the tenant voluntarily improves the property, then it’s unfair to the tenant if this is used to increase the rent & unfair to the landlord if it limits the rent.

Question 57

Where is the new rent documented?

Answer 57

Once the parties have agreed the new rent, or failing that, the new rent has been determined by a valuer - the new rent is documented in a rent review memorandum.

Question 58

What is a rent review memorandum?

Answer 58

A short document (usually single page) that records the new rent, is signed by the landlord and tenant & is kept with the lease for future reference.

Question 59

If the rent review is before the 5th anniversary of the term commencement date, does the tenant have ti pay further SDLT or Land Transaction Tax?

Answer 59

Yes, the tenant may have to pay further SDLT/LTT - as this is calculated on the first five years rent.

Question 60

If the rent review is on or after the 5th anniversary of the term commencement date, does the tenant have ti pay further SDLT or Land Transaction Tax?

Answer 60

No.

Question 61

What if the new rent has only been agreed some time after the rent review date set out in the lease?

Answer 61

The new rent is backdated to the rent review date - this means the tenant will have to pay an additional sum plus interest at a rate set out in the lease (this shouldn’t be a punitive rate of interest).

Question 62

What are the different options for rent review?

Answer 62

1) Stepped rent

2) Index-linked rent

3) Turnover rent

4) Open market rent