Commercial property contracts: what you should be reviewing now

The world of commercial property is likely to face some challenging times over the coming months and years. Landlords and property owners must stay aware of changes in demand within their market, and businesses renting out commercial spaces will need to keep a close eye on their business needs, their property costs and the benefits of remote working.

So, if you’re an owner-managed business that’s currently renting commercial property, what are the key elements you should be considering and reviewing when it comes to the legal side of the rental agreement?

Mark Izquierdo, partner at HW Business Law, explains which key areas of a property contract you should be concerned with, and how to safeguard your position as the tenant.

A challenging time for commercial property

As a relatively new partner at HW Business Law, I chose a challenging time to change roles and become a part of the Haines Watts’ network of commercial property specialists.

With 20 years’ experience of offering legal advice on development work, property investment portfolios and secured lending for property projects, I’m no stranger to the commercial property sector – but no-one, myself included, had truly bargained on the impact of COVID-19 and the effect that the ‘new normal’ would have on the property industry.

COVID-19 arrived and we’ve all had to adjust our concerns as owners. We’ve had to look at cashflow, we’ve had to question the legitimacy of our expenses and overheads and, most pertinently, we’ve had to look at our property costs.

For owner-managed businesses that are leasing office or production space, rent is likely to be one of your company’s largest overheads. And with fewer people now working from your spaces as a result of COVID-19 health & safety measures, you may well be considering downsizing, subletting or even getting rid of your commercial rental altogether.

So, how will this pan out if you DO want to take a break from your existing rental agreement?

Reducing your property pain

If your business is currently leasing a workspace then you’ll already be locked into some form of contractual requirement. But this contract won’t have taken into account COVID-19, pandemics and the effects of an impending global recession – although you’re very likely to see such clauses coming into play going forward.

Over the course of lockdown, many business premises were empty, hemorrhaging money in rent for an empty building. But unless you had a break right, or were coming to the end of the tenancy, you were stuck in this contract, and paying rent on a building you’re not using.

As the business owner, this challenging scenario raised two key concerns:

  1. What can we do today to make these rent issues less painful?
  2. Longer term, what can we do to change our property requirements?

Reducing your need for larger office spaces, cutting your rent overheads and entering into contractual agreements that favour the rights of the tenant are all great ways to tackle these two key concerns – but it’s important to rethink your entire approach to property requirements.

The impact of remote working and lockdown

Remote working during the lockdown period has changed everything, and it’s probable that many businesses won’t have the same office requirements in the post-lockdown landscape.

You may only have a quarter of your people coming into the office on a regular basis, and hot desking, agile working and activity based working will all be used a lot more. So, rather than needing X square feet of space, you may only need Y square feet – and that need for downsizing is going to have a huge impact on the demand for commercial property.

One client I have worked with for many years has given his assessment of the commercial property market showing the challenges we face:

“Many retail and office tenants have struggled to pay rent during the pandemic. Several of my landlord clients have taken the decision, where they are able, to defer or waive rental payments where there is evidence that the tenant has suffered genuine hardship to help them through this very difficult period.

One client, that owns a central London office block, has seen several tenants either pull out of lease renewal negotiations or exercise break options due to the current uncertainty, resulting in a number of voids in the building. This has had a severe impact on their rental income. The current uncertainty is likely to continue for some time. There is also anecdotal evidence to suggest that many tenants do not expect to return to anything like the levels of staff occupancy in central London by comparison with the position pre-March 2020. The likelihood is, therefore, that office availability levels will rise.”

(Property Manager, Surveyor, Substantial Investment Portfolio).

Light industrial space is the area that most property companies now want to be in. 10-15 years ago, people were coming out of light industrial space and into retail, and now it’s the reverse. We’re seeing a real evolution in the property market , with retail being turned over to residential usage, more focus on manufacturing space and a decrease in the demand for large, open-plan corporate office spaces – partly, as a response to the pandemic, but also due to the growth of e-commerce.

Your options when a change of workspace is needed

With your property requirements changing, and the commercial property market in a state of such flux, it’s possible that you’ll want to exit your current tenancy agreement. But what options do you actually have for doing this?

Some core options include:

  1. Serving notice on your tenancy agreement – if you want to end your tenancy completely and move out of the building for good, then this is an option. You’ll need to serve notice on your landlord observing the strict terms of the break clause provisions in the contract you signed up to. If there is no right to break, you’ll be tied up contractually until the tenancy expires.
  2. Agreeing a surrender or variation with the landlord – if you want to leave completely or agree on new terms for your rental property – such as changing the rental level, or having the ability to sub-let etc. – you’ll need to agree terms for a surrender or variation with the landlord. The landlord isn’t obliged to agree to anything, and their response will very much depend on their current and future plans for the property, if it’s over or under-rented and whether they see a positive business outcome to the agreement from their perspective.
  3. Subletting to a third party – one way to ease your financial woes around rental payments is to sub-let your existing space to a third party, bringing in additional income to cover the rent. In this scenario, another company occupies all, or part, of the workspace and then pays rent to you. You then pay the landlord. With additional parties in place this reduces your exposure somewhat and makes it easier to meet your cash flow payment liabilities.
  4. Assigning to a third party – one could consider marketing the property and finding another party (perhaps downsizing themselves from larger, surplus space, premises to one your size) who could take a transfer of your tenant’s interest in your lease for the remainder of the term. Though you may be required to guarantee their payment of the rent and performance of the tenant obligations under the lease, at least you would sit behind a third party primarily liable to make those payments and perform those obligations in the first instance. It could also be likely that this might trigger a surrender conversation with your landlord, to facilitate them granting a fresh new lease direct to the new party.
  5. Falling into arrears with your rent payments – if your business is in a truly dire cashflow position, you may not be able to pay your monthly rent payments at all. If you default on the payments, the landlord will almost certainly want to get the building back so it can be re-rented to another business, but they’ll only do this if they can be certain of marketing and renting the property and not missing out on further rental income. If your landlord is reasonable and commercial, they may be minded (not obligated) to agree some concessions on rent (by way of a side letter arrangement for example, switching to monthly (rather than quarterly) payments of rent, deferring payment for a while until the business activities pick up again and making the payments becomes more affordable).

In all of these scenarios, a good working relationship with your landlord will be helpful, and it’s likely that most landlords will want compensation for any breaks, new agreements or empty properties that leave them with an unpalatable hole in their rental income.

Do you have the right to a break?

In scenario 1 above, where you want to end the tenancy early, it’s vital that you have a break clause already in place in the contract.

Reviewing the small print in your tenancy agreement will help you to confirm if you do, indeed, have a break right, whether you can exit early from the contract and whether there are specific conditions to you being able to do this.

Most commercial landlords will require you to give notice of 6 months plus, and will also want you to yield up the property in good repair, without any other occupiers (subtenants) and with all service charges and maintenance payments having been made, repairs all looking shipshape and the premises ultimately being yielded up in good order.

When you’re potentially locked in to spending thousand/millions of pounds in rent over the remaining lifetime of your lease, it’s prudent to spend money on a legal adviser who can undertake an appropriate review of the contractual documents . This might seem like an unnecessary expense, but you get what you pay for – a property lawyer will be able to review the conditions and clauses and may well be able to help you considerably to negotiate a better position with the landlord, potentially saving you considerable sums of money..

Leases have also become shorter in recent times, which is another element to factor in. Commercial property used to operate on 15 to 20-year leases, but changing demand and evolving legislation has brought the average lease period down to closer to 5-10 years .

Bearing this all in mind, it’s important to work closely with your lawyers and to look at what options you have in your current contract, or in any new contract that you enter into. You might even need a mini property audit to get some pointers on different options, leading to dialogue and negotiations with the landlord.

Getting the legal support you need

Being able to achieve your property goals within a commercial property agreement all comes down to bargaining strength.

As the owner of a small business, you’re up against a landlord with a long-term established property management and collaborative legal team. You may be renting for the first time, or only reviewing your contract once every ten years. So you need good advice and great options – and this is where Haines Watts Business Law comes in.

By getting us involved early, we can advise and guide you, helping you to increase your bargaining strength and achieve favourable results.

We’ll project manage the transaction to ensure you have the best shot at securing:

  • A good deal when it comes to price, location and your business requirements;
  • The right tenure, so you have optimal conditions within the lease agreement;
  • The right break clauses, giving you flexibility on being able to exit early;
  • The right compliance, so you’re code-compliant and meet all the reasonable landlord-tenant-friendly industry norms.

With the commercial property market in a current state of ‘crisis’ or ‘transition’ (which can be seen either as presenting a danger or an opportunity), having an experienced team of property lawyers and business advisers on your team has a huge amount of value. We’ll sit down with you to understand the aims and objectives of your business going forward, what you want from the premises and the conditions you need included in the agreement.

If you’re struggling with your current lease agreement, or thinking of entering into a new contractual agreement for a new workspace, please do come and talk to us.

Talk to one of our lawyers about your property requirements