Commercial Property Essentials: Taking A Short-term Lease Of A Unit Within A Larger Building

We discussed key points to focus on when acquiring a unit within a larger building in our last article and much of what was covered there will also be important to consider when leasing a unit on a short-term lease (less than a 20-year term).

Below is a high-level overview of the key areas to consider when leasing a commercial unit as an occupational tenant.

Rent and Rent Reviews

In commercial leases, rent is typically recorded as an annual amount which is then paid quarterly (or sometimes monthly) in advance. You will need to understand whether the terms of the lease permit the landlord to charge VAT in addition to the rent reserved, and if so, whether you as the tenant can recover such VAT. Rent is typically payable by direct debit or credit transfer, and the lease should clearly specify the payment method and whether this can be changed unilaterally by the landlord during the term.

Most leases will also contain rent review provisions; this allows the rent to change throughout the term via mechanisms set out in the lease. While each lease is different and needs to be reviewed, generally rent reviews occur at 5-year intervals. The rent review may be triggered by either the landlord or tenant or the landlord only, depending on how it is drafted. A tenant should require the ability to initiate a review to avoid backdating of a review in subsequent years. The most common methods of calculating revised rent, are either by reference to "Open Market Rents" or by linking the rent to changes in specified indexes, usually the Consumer Price Index. Open Market Rent reviews determine rent based on the yearly rent at which the premises might reasonably be expected to be let on the open market with vacant possession by a willing landlord to a willing tenant, subject to certain assumptions (such as the premises being fit for immediate occupation and the tenant having complied with its covenants) and disregards (such as the tenant's own occupation, goodwill, and any works carried out by the tenant at its own expense). Where the parties cannot agree on the reviewed rent, the matter is typically referred to an independent surveyor acting as either an arbitrator or expert for determination. In this jurisdiction, there is a prohibition against upwards-only rent reviews introduced by Section 67 of the Land and Conveyancing Law Reform Act 2009. However, to mitigate a landlord's risk the concept of "cap and collar" rent reviews is regularly included in a rent review clause, this puts a "cap" on how much rent can increase by and similarly a maximum amount the rent can decrease by, the "collar". It is important to note that time is generally not of the essence in respect of rent review notices, meaning failure to comply with specified timeframes should not deprive parties of the right to have the rent reviewed. Understanding when the rent review may take place, who may trigger it, and how the revised rent is calculated is essential prior to entering into a new lease.

Term and Break Options

If a commercial tenant is in occupation of a property for more than 5 years they may accrue a legal right to a new lease on market terms. Many landlords will seek to avoid such rights accruing and either set lease terms at 4 years and 9 months or require the tenant to sign a deed of renunciation (sometimes both). A deed of renunciation is typically a single page legal document in which the tenant waives their right to a new lease under the relevant legislation. A deed of renunciation must be in writing and the tenant is required to obtain independent legal advice before executing same.

You will also need to be clear on whether there is a break option in the lease. A break option allows either a landlord or tenant to break the lease early under certain conditions and at a specified date. Break options can be very valuable to tenants but may be resisted by landlords who may want certainty of their rent roll for the full term of the lease. These are not standard provisions and are usually commercially negotiated by a landlord on a case-by-case basis. When exercising a break option, it is vital to check the provision for any conditions (such as the option being personal to the original tenant only) and ensure all dates and notice periods are strictly adhered to. Landlords may challenge the validity of break option notices on technical grounds, so precise compliance with the lease terms is essential. If a landlord has the benefit of a break option in a lease it will be essential that they also obtain a deed of renunciation from the tenant. If no deed of renunciation was executed by the tenant and they had acquired statutory renewal rights the landlord break option would not be exercisable.

Service Charge

If you are leasing a unit within a larger building you can expect to be required to contribute towards the cost of upkeep and maintenance of the common areas within that building, this is dealt with through the service charge regime, administered by the owner or management company for the building. Before entering into the lease you should review the service charge budget for previous years, understand how the service charge costs is apportioned between the owners / occupiers of the building and be aware of any upcoming exceptional expenditure which may be taken from the sinking fund. Key issues in service charge negotiations typically include: (a) what expenses cannot be charged through the service charge (such as repairs related to inherent defects arising from defective design or construction, capital improvements, refurbishment costs, and advertising expenses); (b) whether the landlord is required to contribute in respect of vacant units; (c) the establishment and application of a sinking fund for major future expenditure; and (d) the method of apportionment of costs between tenants, which may be based on floor area, rateable value, or other agreed metrics.

Insurance

As with buying a unit in a larger building, when renting a unit it is typical that a head landlord will be insuring the building itself. If that is the case insurance may be recouped from occupants through the service charge for the building or as a standalone charge. From a tenant's perspective it is important to review the lease provisions relating to insurance and ensure that insurance covers loss of rent and that in the event of damage to the unit rendering it impossible to use, the tenant has the benefit of a rent break while the landlord claims on the insurance policy for the loss of rent. The tenant should seek to be noted on the landlord's insurance policy as an interested party and request a waiver of the insurer's subrogation rights against the tenant (effectively preventing the insurer to recover the loss for the insured damage from the tenant). A non-invalidation clause should also be included in the policy to protect the tenant such that the insurance will not be invalidated due to actions of the landlord. The landlord's insurance policy typically includes cover for loss of rent and service charge for approximately three years, providing the landlord with protection during any reinstatement period. You will also want to ensure that there is a requirement on the landlord to apply any insurance payout to rebuild or repair the build and/or unit. The lease should also address the position regarding damage caused by uninsured risks, including whether the tenant has a right to terminate the lease if the landlord does not opt to reinstate the premises within an agreed period. Section 40 of Deasy's Act 1860 entitles a tenant to surrender its lease where the building substantially constituting the demised premises is destroyed or becomes uninhabitable by accidental fire or other inevitable accident, though landlords typically seek to exclude the application of this provision in the lease.

Condition

Typically, a commercial lease will require a tenant to keep the unit in good repair and condition. For clarity for both the landlord and tenant it can be useful for a schedule of condition to be prepared and appended to the lease. The schedule of condition should show and describe in detail the physical condition of the unit on the grant of the lease, typically by way of dated and referenced photographs. The lease should contain an express provision whereby the tenant is not obliged to maintain the premises in any better state of condition or repair than that shown in the schedule of condition. The schedule of condition is agreed between the parties in advance and shows the actual state of repair and condition of the unit at the commencement of the lease. Where there is a schedule of condition the repair obligation on the tenant will be amended by their solicitor to keep the unit in good repair and condition provided the tenant is under no obligation to return the unit in any better state of repair and condition than evidenced by the schedule of condition. This can prove very helpful when coming to the end of a lease and if a schedule of dilapidations is served by the landlord. In our experience, in negotiations and at the commencement of a lease, tenants can often underestimate the (often considerable) cost of reinstating a premises to its original condition and so these elements of the negotiations should not be disregarded. The tenant should also ensure that the lease explicitly provides that the tenant is not responsible for damage caused to the premises by an insured risk, save in the case of tenant negligence where the insurance monies are not paid out to the landlord to remedy the damage.

Commercial Rates

While you will not own the unit, as occupational tenant you will be the rateable occupier for the purposes of commercial rates. This means:

• You need to factor in the cost of annual commercial rates in addition to the rent, service charge and possibly insurance contribution
• You need to ensure that commercial rates for the unit are paid up to the date of completion; and
• You will need to file a Section 11 Notification to the local authority notifying them of change of rateable occupier within 10 working days of entering into the lease

The Technical Legal Points

Your solicitor will need to carry out a certain amount of due diligence to ensure that (i) the landlord owns the property and has the right to rent it out and (ii) at least from a tabletop review there are no issues with planning, building regulations or fire safety compliance. Where the landlord's interest in the premises is charged to a lender, the consent of the lender to the grant of the lease may be required. It is crucial to obtain lender consent in these situations, as a lease could be set aside where lender consent is required and not obtained. A tenant should also insist on being provided with a letter of non-crystallisation from the landlord's lender where the charge has a floating element which could crystallise and attach to the premises.

After the lease is entered into

After you enter into the lease certain returns need to be made as listed below:

• Section 11 Notification to local authority re rateable occupier – typically this is submitted by your solicitor within 10 working days of completion
• Stamp Duty return – the tenant is liable to pay the stamp duty. Filing and payment must be made to Revenue within 44 days of completion.
• PSRA filing (commercial lease register) – a return to the Property Services Regulatory Authority must be made be a tenant of a commercial lease within 30 days of the stamp duty certificate for that lease issuing. Your solicitor will provide you with the relevant details required to make this return, this is a free return made online.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.