09th April 2020
Commercial Leases: Lessons of Lockdown
The economic shock to business caused by the coronavirus lockdown does call into consideration certain aspects of standard leases of commercial property that the industry has taken for granted for decades. Being impartial, could we consider the following?
- All-inclusive rents: If we stopped charging floating service charges, tenants would be better able to plan their cashflow and landlords would be incentivised to drive down the costs of the services consumed, because the landlords would thereby increase their profits.
- Quarterly v Monthly rental payments: From the perspective of occupiers and their cashflows it seemed crushingly unfortunate that the start of the lockdown virtually coincided with the March quarter day for rent payments. Not only would a move to monthly payments assist with occupiers’ cashflows, if it were universally implemented, monthly rent payment would make landlords’ accounts departments and managing agents less pressurised at quarterly pinch points. After the first two or three months landlords could also benefit from a more even cashflow– particularly landlords owning significant portfolios.
- Short term leases: This is only a continuation of a trend that goes back beyond the start of this century, but wouldn’t even shorter terms for leases, meaning not just terms of 5 years, but 3 years or even 18 months be worth consideration. Tenants should realise that they would have to pay a higher price for the flexibility of short terms, but with hindsight that might now look like a price worth paying.
- Break clauses: Offering open tenant break clauses, without onerous conditionality, has been a clear request from tenants and their advisers for some years now. However, the case for ‘clean breaks’ will be made even more clear as tenants put their break rights to the test in the near future. On the basis that tenants have to “buy” break rights with higher rents they will not find it easy to take if these rights turn out to be illusory in practice.
- Amortised dilapidations payments: This concept is a bit more innovative, but if tenants expect to receive they will have to give, and this could be one such area. With lease terms falling to 10 and 5 years it has been increasingly challenging for landlords to get tenants to sign up to sinking funds or reserve funds. The problem then is that a floating service charge becomes a game of financial Russian roulette – an occupier might get 5 years of low service charge costs and then metaphorically, if not literally, the roof falls in! If instead proper building surveying techniques are brought into play you could easily get a fair result all round. A building’s repair costs could be worked out over a long period, perhaps over the projected working life of the building and then converted into a fixed, or index linked service charge, for the tenants. This could also encourage the building of higher quality building stock in the first place.
- Alternative tenant’s repairing obligations: This is quite an obvious point, and we have long since moved from a time where it was a fait accompli that a lease would contain the classic obligation on the tenant to keep the premises in “good and substantial repair and condition.” More and more common are clauses that limit the tenant’s repairing obligations to standards such as “tenantable repair” or, occasionally, even “wind and watertight” and the use of schedule of conditions are now quite common in this regard. Just to throw this out there, but as long as tenants were not to actively or negligently damage the premises (and this could maybe be monitored by CCTV – although that is another issue), could we consider some leases where the amortised cost of repairing the demise is fully integrated into the basic rent?
- Force majeure clauses in leases: This is a debate that will no doubt be had, but it would seem to simply be an apportionment of risk as to whether tenants start to have the benefit of force majeure clauses, meaning that they could terminate their lease contracts in the event of unforeseeable, act of God like events. Tenants should realise that if they are pushing risk in the direction of the landlords then higher rents should probably be the price. However, whilst the lease is a special sort of contract, it is nonetheless a form of contract, so there is no intrinsic reason why leases should not contain force majeure clauses if the parties freely negotiate them.
It is likely that with further consideration and the hindsight brought by the Coronavirus lockdown, we will see many more suggestions as to how leases could be drafted differently. Although, it could equally be the case that after an initial froth of debate any impetus for change drains away. The commercial lease is a very traditional form of legal contract, which in all honesty does derive from a time when freehold property ownership had a revered status. Historically, the lease was shaped into its now well-known institutional form in an attempt to make rental income as similar as possible to dividends on company shares. Undoubtedly, the traditional approach to lease drafting and negotiating is changing. How far and how fast that change goes, or should go, is an open question and only time will tell. On the one hand there is a lot to be said for holding a line that protects real property as a competitive asset class in the eyes of investors, but on the other hand real property has to be flexible and adapt to the needs of those who use it and, after all, supply the money, in the form of rents, on which the pyramid rests. It is conceivable that the future could see two very distinct models of leases, perhaps existing side by side – there being institutional leases with lower basic rents but with all the old certainties of income stream for the institutional landlord, but also occupational contracts with shorter terms and all-inclusive rents and more lenient tenant repairing obligations – the latter might be more appropriate for smaller business occupiers and more entrepreneurial landlords.
For more information please contact David Wells on 01908 247030 or click here to email David.