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Occupying Commercial Property

Occupying commercial premises can be a complex task for tenants, particularly if they are a small company trying to get a foothold in the market. This advice page breaks down the various methods by which tenants can acquire an interest in commercial premises.

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Different types of commercial lease

There are four key ways of acquiring and occupying commercial property other than the purchase of a freehold: a new lease, an assignment, a sublease and a licence. Below is a brief breakdown of what these four terms actually mean and how they can affect commercial property.

New lease

A new lease is a subordinate interest in property granted by the freehold owner. The owner will grant the new lease to the tenant, giving a legal interest in the premises and exclusive occupation for a definitive term at a specific rent.

A new lease can be available because the property is newly constructed or refurbished, the lease held by the previous occupier has been terminated or the lease held by the previous occupier has run its course and expired.

The two parties in a new lease arrangement may also be referred to as the lessee (tenant/occupier) and the lessor (landlord/superior landlord/freeholder).

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What are the advantages of a new lease?

Term

Commercial landlords will usually require a minimum lease length of five years. It is rare for landlords to agree to a term shorter than this and many will seek a minimum term that is longer.

However, the landlord may agree to a tenant-only break clause that permits the tenant to terminate the lease at a specific point in the term, subject to certain lease obligations being met. The landlord may also seek for this clause to be mutual, granting the landlord the power to break or conclude the lease at this point if necessary.

A break clause will usually be positioned at a mid or specific point in the lease term. This could be at the conclusion of the fifth year of a ten-year term or on the fifth and tenth years of a fifteen-year term.

Rent level

In a market where demand for space outstrips suitable supply, rents will generally rise, and tenants will have less negotiating power. However, the landlord may still be prepared to accept a rent lower than what is quoted, so it is always worth making a reasonable offer.

The level of rent agreed will depend on the negotiating strength of the parties on either side of the transaction.

Incentives

Market conditions will dictate the negotiating strength of the two parties.

If the supply of suitable commercial space outstrips demand landlords may offer more valuable incentives to secure a tenant. Incentives offered may include things like rent-free periods at the start of the lease and a contribution towards fit-out costs.

If demand outstrips supply, then there may be competition to secure space, so landlords may not offer such generous incentives.

What are the disadvantages of a new lease?

Term

Whilst a new lease does offer certainty of term length, having to commit to such a long minimum term can also be a disadvantage. As 2020 has proved, any number of unpredictable events can impact business occupation. This is a particular worry for smaller, or less established, businesses signing up to a long term lease.

Initial costs

Once agents and legal fees have been paid, the majority of new leases grant an entirely vacant space to the prospective tenant. Consequently, there is then a huge upfront cost required simply to make this functionable for any incoming business.

Time

It can take a long time to agree the terms of a lease, which can put pressure on tenants reaching the end of their current lease and need to be in occupation of their new premises as soon as possible.

Rent reviews

Longer leases will usually be subject to upwards-only rent reviews every five years of the lease term. Fundamentally, this is a point at which the rent level will either stay the same or, more likely, increase with market levels.

Assignment

The assignment of a lease is when an existing tenant ‘sells’ or transfers their lease to a third party giving them the right to occupy the space. When looking at a space that is available by way of assignment, it is important to consider how the current occupier has previously negotiated their lease and all the terms involved. These may come with advantages as well as disadvantages.

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What are the advantages of an assignment?

Term

This can be particularly useful for businesses hoping to take advantage of a shorter lease term. As the lease commences on a specific date, and the assignment of the lease takes place midway through the term, the incoming assignee can benefit from the remaining period.

This could be as short as a few months or as long as twenty years, though the incoming assignee will also benefit from any tenant break clauses.

Rent level

If the original lease was agreed during a period of particularly low rent levels, the incoming assignee could benefit from this same low figure.

Incentives

Any incentives agreed by the assignor will also be transferred to the assignee. For example, if a three-month rent-free period has been agreed following an unused tenant-only break option, the assignee will benefit from this same period if they do not utilise the break.

Initial costs

Upfront costs can be drastically reduced when taking an assignment, or indeed a sublease, because the outgoing assignor will generally look to leave as much of their own fit-out and furniture as possible. If these elements suit the incoming assignee, they could avoid this large upfront expense.

What are the disadvantages of an assignment?

Term

There is no control over the lease expiry or lease break dates when taking an assignment. This may mean an imminent break date (which is of limited use if the assignee has just moved in) before an extended period without the option to conclude the lease.

Additionally, an assignment may well benefit from a lower-than-market rent level. However, longer leases may be subject to regular upwards-only rent reviews which could reduce any low rent advantages.

Lack of control

There is no control over the rent level, landlord incentives or any other obligations that have been previously agreed by the assignor. However, if the outgoing tenant recognises that the lease terms are unfavourable, they may negotiate and incentivise the assignment with, for example, a reverse premium or a dilapidations contribution.

Taking the space “as-is”

The outgoing assignor may leave behind a fit-out wholly unsuited to the incoming tenant. This will then become the assignee’s responsibility to strip-out in order to install their own fit-out. However, a consideration of this cost could form part of the agreement.

Initial costs

As with a new lease, an assignment is subject to similar agents’, legal and due diligence fees.

Time

Assignments can often take longer to agree than new leases as they now include three parties: the landlord, assignor and assignee. Consequently, all negotiations must be agreed by all three parties. There may even be a superior landlord whose consent will need to be obtained.

Subleases

Subleases are where an incoming tenant takes on a definitive lease term from an outgoing tenant. However, in contrast to an assignment, a new relationship is created between sublessee and sublessor because the latter remains in the arrangement as a pseudo-landlord for the sublease term.

Rather than relinquishing control of the lease to another party, the sublessor becomes directly responsible for ensuring that the terms of the original lease are adhered to, even though these terms become, in part, the responsibility of the sublessee.

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What are the advantages of a sublease?

Term

The lease term can be far shorter, being simply for the remainder of the term or until the next tenant break option (at which point the sublessor would seek to enact the break option and formally end their responsibility to both landlord and sublessee).

Rent level

If permitted by the lease, the rent level can be lower than for a new lease. However, many leases will specifically highlight that subletting cannot be conducted at below market rent level. This is generally included to protect the landlord’s investment.

Initial costs

The incoming tenant can benefit from the existing fit-out, fixtures and furniture if left by the outgoing tenant.

Subletting in part

Unlike an assignment, where the entire lease and the premises it refers to is transferred to a new party, some leases will permit a tenant to sublet part of the overall premises to another party. This potentially creates a mutually beneficial scenario for sublessor and sublessee. A smaller business can benefit from a small area within a premium property and the sublessor can supplement their rental payments with income generated from the part sublessee.

What are the disadvantages of a sublease?

Term

A sublease or part sublease implies that the sublessor has agreed to a lease that is no longer suited to their business needs and have had to action a policy that recovers this operational expenditure. Therefore, any sublease will only be for the guaranteed term. The sublessor will naturally look to relinquish their lease responsibilities at the soonest possible point of termination.

Lack of control

Similar to an assignment, the terms of some subleases may be dictated by the terms of the existing lease. Rent will usually be at no less than market level and a sublessee may not be given security of tenure or the ability to negotiate key clauses such as alienation.

Initial costs

There are a lot of fees payable when taking a sublease; agents’ fees, legal fees (of the landlord and any superior landlord) and the fees associated with due diligence checks and surveys.

Time

Transactions involving a sublease can often take longer to agree than new leases as they include at least three parties: the landlord, sublessor, sublessee and their representatives. As with an assignment, the negotiations must be agreed by all parties.

Licences

A licence does not create a legal interest in land, which makes it different to a new lease, assignment or sublease. Instead, a licence is merely the grant of a personal right to use a commercial space for a particular purpose for a fixed or ongoing term. This type of agreement is most commonly associated with flexible offices – co-working spaces and serviced offices.

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What are the advantages of a licence?

Term

Licences are far more likely to be agreed for a shorter period of time, sometimes on a month-to-month rolling basis. Consequently, this can appeal to smaller and less established businesses who have less certainty over their employee numbers. Similarly, the COVID pandemic has resulted in uncertainty over how long some employees will continue to work from home. A shorter term could therefore bridge the gap before a decision is made for a more permanent lease agreement.

Initial costs

Solicitors’ fees to review a licence will be far less than the normal legal fees associated with reviewing and conveyancing a new traditional lease, assignment or sublease. Many would argue that the short-form nature of a licence does not require a solicitor’s involvement, though it is strongly recommended that a solicitor or, at the very least, a property professional should review the licence before it is signed.

Obligations

There are generally far fewer obligations and liabilities to be negotiated between licensor and licensee, especially compared to a traditional lease which can often impose numerous obligations and liabilities on the incoming tenant.

Convenience

Licences generally tend to consist of an all-inclusive monthly fee that incorporates all occupational costs such as rent, business rates, utilities and service charge.

Time

Licences can be negotiated and agreed quickly, unlike a lease agreement which can sometimes take months to negotiate and move through the legal process. There are generally far fewer points to negotiate and there is no legal interest created during the transaction.

Stamp duty

A licence is guaranteed to be exempt from Stamp Duty Land Tax, which will provide occupiers with an additional capex saving compared to new leases and subleases/assignments above a certain threshold.

What are the disadvantages of a licence?

Additional costs

There are a number of additional facilities/amenities that may not be included within the monthly fee for flexible spaces– such as high-speed internet or access to meeting rooms – so be aware of what extra costs you might incur.

Neighbours

Particularly within flexible office space, there is often very little control over where the licenced space is positioned on the floor and who the floor space is shared with. This could mean sharing space with people making noisy phone calls or having loud meetings.

Alterations

Typically, alterations to the licenced space are not permitted. Usually, this will be because the term the space is taken for is so short that approving any alterations is not a feasible exercise for the flexspace operator.

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