Jen Lemen begins a two-part exploration of issues relating to lease renewals, beginning by taking the position of a surveyor acting for a landlord. Next month, we look at the tenant’s perspective.
Lease renewals: acting for the landlord
The following is written for students as a self-study exercise. It could also be used by lecturers as a basis for a seminar exercise. You are asked to consider the questions posed before reading the answers provided online. After this and next month’s article, you should be able to:
■ Understand the lease renewal process.
■ Assess the aims and objectives of both parties.
■ Advise on appropriate negotiation tactics.
■ Understand the operation of the Landlord & Tenant Act 1954.
■ Conclude an appropriate settlement and consider further options.
The scenario
■ A retail shop of 1,500 sq ft NIA/1,000 sq ft ITZA (in line with the RICS Code of Measurement Practice) in the prime retail pitch of a major regional UK city.
■ It is in poor decorative order, with the potential for a moderate dilapidations liability, given a lack of property maintenance over the years by the tenant.
■ Neither party has served notice and the tenant is holding over under Part II of the Landlord and Tenant Act 1954.
■ You, a newly graduated surveyor, alongside your supervisor, have just been instructed to provide reasoned advice to your client, a landlord property company.
Lease main terms
■ 10-year lease which expired in summer 2017.
■ Fifth-year tenant’s break option – conditional on giving at least six months’ notice in writing, paying all rents in full and giving up vacant possession.
■ Full repairing and insuring, including service charge for common parts (as the landlord owns a block of five units).
■ Rent of £200,000 pa.
■ Rent review in year five – upward only to open market value.
■ A1 retail user clause.
■ Assignment and subletting of whole only permitted with landlord’s consent, not to be unreasonably withheld or delayed.
Acting for the landlord
The landlord instructs you and your supervisor to provide reasoned advice on the lease renewal. In your initial meeting, you find out that their objectives are to:
- Consider whether redeveloping the block as one larger unit would create an uplift in value;
- Minimise any void period to maximise rental income and income security; and
- Satisfy their long-term plan to sell the block and make a capital gain on the freehold.
The property company has been deliberating long and hard since the lease expired last year, but has taken no action to initiate renewal discussions with the client.
After the meeting, you need to secure your instructions in writing before proceeding, including your agreed fee level. In doing so you should:
- Check you are both competent to act, eg sufficient knowledge, skill and experience of dealing with similar properties in the area;
- Check for conflicts of interest in line with RICS Conflicts of Interest global professional statement, eg email around firm and check instruction database; and
- Issue terms of engagement for signature by your client, including your fee proposal and any other relevant clauses.
The next step would be to ask for desktop due diligence information, eg copy lease and other deeds/legal documents, floor plans, historic file information, EPC, tenure information for the block, any relevant health and safety information, access arrangements, asbestos report, etc.
This would be supplemented with your own desktop research, eg comparable evidence, surrounding uses, information on the city centre and any wider redevelopment proposals and general retail market analysis.
You then arrange to inspect and measure the property in line with RICS Property Measurement, ensure you assess any health and safety risks before attending the site, in line with RICS Surveying Safely, and make access arrangements with the tenant. On site, you use a laser measurer to measure the unit and inspect the surrounding area, external and then internal parts of the subject unit. You note that the property is in a poor state of repair, with a water leak to the rear store room.
On your return to the office, you collate your information into your lease renewal report, including comparable evidence you have verified with other agents. You issue your report to your client and make the following recommendations:
■ Open market value (on the basis of the statutory section 34 hypothetical lease terms) of £220,000 pa – an uplift of £20,000 pa. The open market evidence suggests that a 10-year lease with a fifth year tenant’s break is the norm. This is an excepted valuation under the Red Book as it is for negotiation purposes.
■ The retail market in this city is currently performing well, with a limited supply of prime units and healthy tenant demand from both established and new market entrants. In particular, a new anchor occupier has opened on the opposite side of the street, creating evidence for an increased rent and minimal void period.
■ You do not believe that redevelopment of the entire block would be a viable option at this time, having carried out a very basic development appraisal, taking advice from a building surveying colleague on the potential costs. The key issues are the build costs and the fact that the lease expiries are not coterminous, which would make securing vacant possession of all five units difficult within a reasonable timescale.
■ EPC rating of E – this means that the property does not currently fall within the scope of improvements required by the Minimum Energy Efficiency Standards. However, you advise your client to consider energy efficiency improvements to mitigate any future risks.
■ The poor condition and water leak could fall within the tenant’s dilapidations liability, so you recommend that your client takes further advice from a building surveyor. You are instructed to try to make the works a condition of the tenant renewing their lease.
Your client considers your advice carefully and instructs you to proceed with the renewal negotiation.
What else could you discuss with the client?
■ You could consider recommending whether redeveloping the block as one larger unit would create an uplift in value. Even if the proposals do not stack up now, you can suggest revisiting the possibility in future.
■ Minimise any void period to maximise rental income and income security.
■ If the client’s long-term plan is to sell the block and make a capital gain on the freehold, suggest that a freehold valuation should be carried out to consider tactics in this respect going forward.
Q&A
Questions
Think about each question and sketch out your thoughts before reading the answers below.
Question 1
What tactics would you apply to secure the best settlement?
Question 2
Notice is then served and the tenant’s agent contacts you to open negotiations. The following key issues arise:
■ The parties have different floor areas on file, by 100 sq ft.
■ The tenant is seeking a nil increase, based on historic evidence from slightly off-pitch properties.
■ The tenant wants the new lease to have a break option in year three and to be in line with the Code for Leasing Business Premises in England and Wales 2007 (the 2007 Code).
■ The tenant requests that the service charge is in line with the latest RICS Code of Practice.
■ The tenant considers that the repair works should be the landlord’s liability, as they do not believe a flat roof to the rear falls within their demise.
How would you resolve these issues?
Question 3
The parties should agree the details of the renewal lease in heads of terms, which are then circulated to solicitors. The parties’ solicitors then formulate the draft lease, which completes four months later.
What happens next and what should you do when the lease is completed?
Answers
Question 1
Recommend serving a non-hostile section 25 notice without delay, terminating the current lease with six months’ notice (the minimum required under the 1954 Act). This is on the basis of a new 10-year lease with a tenant’s break in year five at a proposed rent of £230,000 pa to leave room for negotiations. Serving notice gives rise to interim rent, which you advise should be at the level of the new rent from the termination date stated in your section 25 notice.
Question 2
The parties undertake a joint inspection and agree compromise floor areas. It turns out that the tenant’s surveyor had incorrectly zoned the premises because of the presence of a partition wall in the sales area, while you had different areas for a narrow store room to the first floor.
The parties discuss their comparables and you present your recent open market lettings to the tenant. Eventually, negotiations lead to a negotiated settlement at £225,000 pa as there is a new deal about to complete nearby which supports this level of rent.
You point out that O’May and others (Practising as Ince & Co) v City of London Real Property Co Ltd [1982] 1 EGLR 76 sets a precedent for the renewal terms to follow the existing lease terms – which supports a 10-year lease with a tenant’s break in year five. Given healthy market demand, you see no reason to stand down from this position. You agree that the 2007 Code should be considered and ensure that the heads of terms reflect these, where appropriate.
You agree that the service charge should be operated in line with the latest RICS Code of Practice. This is written into heads of terms.
You examine the lease with advice from a building surveyor and confirm to the tenant that the flat roof is in their demise. The building surveyor agrees a schedule of works to be undertaken which is appended to the heads of terms as a condition of the new lease.
Other tactics you could consider using if the parties didn’t agree on the new lease terms and rent are:
■ Part 36 offer giving strict timescales and cost implications.
■ Calderbank offer giving more flexibility in timings and cost implications.
■ Issuing early court proceedings prior to the termination date stated in the notice.
■ Waiting until the termination date and then issuing court proceedings.
Question 3
■ Issue your fee account in line with your terms of engagement.
■ Put your file in good order for archiving.
■ Diarise the next rent review date for business generation purposes.
■ Thank the client for their business.
■ Create a comparable evidence sheet to hold on file.
■ Ensure that the building surveyor follows up on the dilapidations works.
■ Confirm the new lease terms and rent start date to your client’s management team.
Key skills for a landlord and tenant surveyor
■ Good communication skills – understanding your client’s objectives, listening carefully, writing complex reports and giving reasoned advice.
■ Excellent negotiation skills to reach the desired settlement.
■ Technical knowledge to negotiate effectively and use the process to drive matters forward.
■ Attention to detail to ensure accuracy.
■ Both strategic and logical thinking to assess the most practical way to reach a negotiated settlement.
Jen Lemen BSc (Hons) MRICS is a property consultant, academic and owner of Property Elite. Mainly for Students is edited by Paul Collins of Nottingham Trent University. He is also an external examiner at other universities and an RICS APC assessor. Paul welcomes suggestions for the column and can be contacted at paul.collins@ntu.ac.uk