Laura West and Clare Spokes stress the need to update repairing and reinstatement covenants in the age of the smart building.
Gone are the golden days of commercial landlords securing leases for 20-plus years with no option to break and regular upwards-only rent reviews. In 2019, ever-changing trends and economic uncertainty have left tenants craving flexibility and top-notch technology in return for a premium. With buildings becoming smarter than ever, repairing and reinstatement covenants are likely to need a good nip and tuck sooner rather than later.
The traditional approach
Traditionally, landlords have recovered the (often sizeable) cost of modernising commercial property through long-term full repairing and insuring (FRI) leases, where the tenant is responsible for repairs. The model allows the landlord to recover a lump sum from the tenant (by way of a dilapidations payment) at the end of the term which can then be funnelled back into maintenance and modernisation. However, with average lease terms shrinking to around seven years and the advancement of technology running at the speed of Usain Bolt, is lease drafting keeping pace?
Arguably not. The obligations to repair, redecorate and maintain fixtures, fittings and mechanical and electrical (M&E) installations routinely take up less than a page each in new leases. On repairs, it is common to see short clauses simply requiring the tenant to keep conducting media, plant, equipment and fixtures “properly maintained and in good working order in accordance with good industry practice”. Individual M&E/tech installations are not generally dealt with separately and it is rare to see any definition for “good industry standard”.
A move towards bespoke covenants?
Where tenants are in a position to take a complete building lease, bespoke, detailed clauses might offer numerous benefits for both landlords and tenants. In Langham Estate Management Ltd v Hardy [2008] 3 EGLR 125, Judge Hazel Marshall QC made the observation that an obligation to maintain “may well require proactive preventative maintenance work, or carrying out of adjustments or general servicing before any actual fault develops or want of repair exists”.
If prevention really is better than cure then, in the context of very costly or sophisticated systems or products, it will significantly assist all parties to spell out at the outset what technical standards should be met, narrowing the scope for disputes at the end of the term.
But these concerns need to be balanced against the commercial drivers – shorter leases are quicker to negotiate, which means the asset becomes income-producing sooner.
The need to modernise schedules of condition
The traditional method of recording repair and condition in a photographic schedule is akin to fitting a square peg in a round hole when it comes to technology, yet parties routinely omit to do more than append such a schedule to the lease, leaving wide scope for disputes.
Commissioning reports from a number of suitably qualified professionals (lift engineers, heating and cooling specialists, etc) at commencement would assist in resolving issues arising in relation to whether the tenant has properly maintained installations. Professional advisers will need to step up to ensure such reports are settled and agreed promptly to avoid possession being unnecessarily delayed, albeit that standards of maintenance and inspection could feasibly be agreed after commencement once the tenant is in.
Moves away from capital contributions
Similarly, the traditional approach saw tenant fit-outs specified and built at lease commencement, with costs amortised over 10- or 15-year terms. As such, longer-term leases made sense. Now, to keep pace with changing business requirements, tenants are demanding buildings with “plug-and-play” capability – that is, fitted with air-con and electrical installations which are compatible with regular changes to layout via internal demountable partitioning and fewer structural columns.
A decline in the popularity of landlord’s capital contributions towards extensive fit-outs seems likely, as does a trend towards the provision of services by the landlord, such as Wi-Fi, which the tenant is obligated to take as part of the lease terms. This is already relatively common in retail, (for example, units in Westfield come with requirements to sign up to landlord’s services for Wi-Fi and utilities).
It may be that landlords find that they can shift a greater proportion of the costs relating to maintenance and modernisation on to tenants by charging a premium on such services throughout the duration of the term rather than looking to recover a lump sum at the end of the term.
The cost of modernisation has always been high, but in the context of an uncertain economic outlook, the growing pace of technological change looks to increase the tension between landlords and tenants as regards who will foot the bill. Who will be left out of pocket may well depend on who is paying attention to the finer details.
Drivers for change
Forces affecting the office lettings market include:
Buildings of the future
Developments such as The Edge (Amsterdam), the Glumac buildings (LA and Shanghai) and 22 Bishopsgate (London) are leading the way with regard to what is possible, and offer a window to the future. The 56-storey 22 Bishopsgate is a WSP project which will embody the values of its Future Ready programme, and is likely to be one of London’s most advanced smart buildings when completed.
More affordable technology
The demand for smart buildings is booming. Tenants are aware that previously aspirational tech – such as the ability to control internal microclimates via user-determined temperature, lighting and ventilation levels – is now within their reach.
The ‘WeWork’ effect
Tenants are seeking out future-proof, flexible space with the capability to host plug-and-play office layouts – preferably with the ubiquitous beer tap and barista thrown in.
Green offices
There is real demand for energy efficiency through the use of heat recovery systems and smart glass, which can maximise natural light and drive down energy consumption and costs.
Laura West is a barrister in the real estate litigation team and Clare Spokes is an associate in the property investors team at Penningtons Manches LLP
