More so than ever, tenants are assessing the suitability of their current commercial premises. The advent of working from home has encouraged decision makers to question whether they need such large offices and the dependency on e-commerce has prompted many retail tenants to abandon their shops in favour of warehouse distribution.
However, exiting a lease is not a straightforward process and requires careful consideration. This page breaks down how tenants can dispose of their leased workplace.
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The main methods of disposal are by way of surrender, assignment and subletting.
Surrender offers tenants a clean break and is the preferred method. Lease assignment and subletting also provide tenants with an opportunity to dispose of their property but in these two scenarios the tenant will usually have continuing obligations. In most cases tenants will only be able to dispose of the entire property by way of a surrender, assignment or sublease. Although, some leases permit subletting in part.
This occurs when a tenant surrenders their interest in the property back to the landlord.
Surrender is not used as frequently as assignments or subleases and may only be achieved with the landlord’s agreement. In reality, a surrender rarely takes place unless the landlord has another tenant ready to take occupation. Indeed, as long as the original tenant can afford to pay the rent, the landlord will be reluctant to enter into surrender discussions without the prospect of a new tenant to take on the empty space.
An assignment is a method of disposal which involves an incoming tenant taking the place of the outgoing tenant and taking on the legal interest in the property. In a basic sense, it’s as if the name of the outgoing tenant were erased from the lease document and replaced with that of the new tenant.
A sublease is a lease, by a tenant, of their entire premises to another tenant, but with the original tenant retaining some right or interest under the original lease.
Similarly, a part sublease refers to a portion of the premises being leased to another tenant. Most commonly, this may occur when a tenant occupies multiple floors or units of a property and they wish to dispose of a single floor or unit whilst retaining the remainder of the space.
Rights of disposal are referred to as rights of alienation within a lease document and should always allow tenants to dispose of the whole of the premises with the landlord’s consent. But landlords may set out circumstances in which consent can be refused, such as where there are arrears of rents or service charges, that are not the subject of a legitimate dispute.
Moreover, if the landlord reasonably requires it, leases may also provide that the assigning tenant enters into authorised guarantee agreement (AGA) with the assignee. An AGA will place the outgoing tenant in the position of guarantor to the incoming tenant. It is therefore a fundamental consideration for all assignors to ascertain the covenant strength of the party that they will be responsible for.
Leases usually allow tenants to sublet the whole of the premises and may also allow subleases of parts, if appropriate, with the landlord’s consent. Subleases are required to be on terms consistent with the tenant’s own lease and usually at rents not less than market rent. However, subleases which are to be excluded from statutory renewal rights and subleases of only part of the premises may be granted on different terms where appropriate.
Often, there may be a clause that states that the tenant may not underlet the premises at a rent level below market rent. This can be a problem for tenants looking to sublet where the priority is to dispose of the space as quickly as possible and to generate the most appeal in the market. However, leases may offer ways around this, including offering rent free periods or reverse premiums.
When offering space back to the market, it is important to appreciate that it could be an extremely lengthy process. Assigned or sublet space can often sit below a new lease in terms of the interest they generate. Additionally, it can often be months or even years before the property is disposed of and, for every month that passes, the remaining term shortens which reduces the appeal of the space and extends the tenant’s financial loss.
Once a tenant representative has been appointed, it is critical to review what is and is not permitted by the lease. In order of preference, it could be argued that a tenant should attempt to surrender their lease, then offer it to the market by way of assignment and then offer it to the market by way of a sublease, if each of the prior options are not possible.
A surrender would release the outgoing tenant from any further obligations but is the least likely to be granted. Nevertheless, it may be possible to negotiate a surrender if the deal can satisfy the landlord.
An assignment may release the outgoing tenant from any further obligations in some circumstances, but it is dependent on the discovery of an assignee to take the space and there not being an AGA in force.
A sublease would not release the tenant from its obligations and would be dependent on the discovery of a new sublessee to take the space for the remaining term.
It may be that the existing tenant’s fit-out is sufficient to attract an occupier but this will depend on the standard of competing premises also being marketed. The sublessee or assignor should decide whether to refurbish the space prior to marketing.
Moreover, the outgoing tenant must also consider their dilapidations/reinstatement liability when assigning or subleasing. The assignee or sublessee could argue that they require a contribution towards the dilapidations works or settlement.
The appointed tenant representative will act on the outgoing tenant’s behalf to seek landlord approval for the disposal of the space. Prior to appointment, they should be able to showcase their experience in disposing of property, the marketing material they can create and the exposure that they have to the commercial property market.
It is important to be aware of the occupancy costs associated with the space and how it compares to the rest of the market. This will be discussed with the tenant representative, as the market may have risen making the current rent level of the marketed space seem extremely appealing. Alternatively, if the market is in decline and landlords are dropping rents and providing greater incentives (which is expected post-COVID-19), an assignment or sublet that retains the market rent level of a previously strong market may no longer be perceived as such a great deal.
Lease surrenders can be done formally through a deed, but this is not always necessary. If it is in the best interest of all parties that the landlord is returned possession of the space, this can be a fairly quick process that involves an unequivocal act of the tenant vacating and the landlord re-taking possession of the property. However, if the landlord is dissatisfied with the prospect of losing a tenant, it may be that the parties need to come to an arrangement where the landlord will be content to grant the surrender. This may take weeks, but it may also take months to occur.
The timeline for disposal is mostly dependent on market forces. It is also important to consider how long is remaining on the lease and establishing whether it is commercially viable to undertake the process of disposal. Indeed, with only a year remaining on the lease term, it may cost a large amount of time and money to actually get the space out to market, only for months to pass without any indication of appetite for the space from potential tenants.
In terms of a timeline from establishing whether an assignment or sublease is possible, to actually disposing of the space, it very much depends on the state of the market. Even in a relatively buoyant market, it may take anywhere between six to eighteen months to achieve a letting.
The construction, mechanical and electrical works that are required to divide a single demise into two can often be an expensive undertaking. It’s incredibly important for surveys to be conducted and to get detailed quotes for the works required in order to understand whether the route is financially viable.
Solicitors will process the transaction and be required to interact with the solicitors of both the landlord and the incoming tenant. Similarly, it is common for the outgoing tenant to cover the landlord’s legal fees during the transaction.
In a turbulent market, a number of concessions may have to be made during negotiations. This may be covering the dilapidations/reinstatement liability, it may be offering a reverse premium or rent-free months, or it may be as simple as leaving behind any furniture for the benefit of the incoming tenant. An initial upfront expense may ultimately be required to secure a long-term saving.