02 January 2018 #Commercial Real Estate
Most potential commercial tenants will budget for what they expect to be the usual costs of taking a lease, such as the main rent, legal fees and any rent deposits required by the landlord, but often there are some hidden or unexpected costs that also need to be considered.
Often tenants will agree the basic terms at an early stage and although these Heads of Terms are not usually binding a landlord will often insist the tenant keeps to the essence of what was agreed. It is therefore important to ensure the Heads of Terms protect you in some key areas that could affect your cash flow and expenses. It is therefore always a good idea to run the draft Heads of Terms past your solicitor who should be able to help curtail some of these potential issues.
What follows are some common additional costs that all potential commercial tenants need be aware of along with some tips on how these costs can be kept in check.
VAT and SDLT
As is to be expected it is usually not possible nor advisable to avoid tax payments and the most common in a property lease are VAT and Stamp Duty Land Tax (“SDLT”).
Points to note here are that dependent on the level of rent or premium paid under the lease you are likely to be required to pay some SDLT. You should find out what this will be early on to enable you to budget for it. Also note that the SDLT is due on the market rent for the property and so if you have agreed an all-inclusive rent then this should ideally be split out in the lease to ensure you are only paying the tax on actual rent for the property. Tenants should be wary of any rents that are below the market rent as HMRC could pursue you for the SDLT on the full market rental value. Always check with your accountant if you are not sure.
Finally, on SDLT, once your lease completes you have 30 days to pay the SDLT due, otherwise HMRC are likely to charge a minimum penalty of £100 and may charge interest too.
If a landlord has elected the property for VAT then you will be required to pay VAT on all relevant supplies including the rent. If you are also registered for VAT then you will be able to claim this VAT back but you need to bear in mind the effect this can have on your cash flow.
An issue that often causes confusion is VAT on rent deposit monies. If a deposit is required by the landlord then they will often insist the figure also “includes VAT”. Be wary here because what they mean is an amount in lieu of VAT, as the supply for VAT on the deposit does not occur until the landlord dips into the deposit due to the tenant defaulting under the lease. As such you will not be able to reclaim the VAT until the landlord uses the funds or otherwise when the lease ends or is assigned you should then be able to recover the full deposit if there is no outstanding default. You need to budget for this cash flow issue.
Service charge and repairs
You should always try to agree a cap to your service charge payments otherwise you could get an unwelcome surprise if the landlord incurs a large expense such as repairing the accessway, roof or windows to the building that your unit is in. As an alternative you should seek to agree some items that you will not be responsible for paying towards. Often the landlord will agree that any capital costs on the building or repairs due to faults in construction can be excluded from your liability. Also, always ensure you check if a reserve/sinking fund exists or whether there are any high anticipated future costs as well as finding out the proposed estimated service charge and checking any building survey as this should give you an idea of any potential costs that could be coming.
Do not forget that you will be responsible for repairing your own demised area and so you will need to budget for any costs in this regard, should some unexpected repairs surface. A common way to limit your repairing liability is to agree that the lease will attach a photographic schedule of condition and that you will not be required to repair anything into a better state than shown on that schedule.
At the end of your lease you will usually be required to remove any works you have carried out to the property and make good any damage caused in doing so and to make sure the property is put back into the state you took it in. Often, the landlord will instead agree a sum, payable in lieu, with the tenant rather than requiring them to carry out the reinstatement works. It is always worth instructing a solicitor or surveyor at this stage, as they will be able to seek to reduce your liability as much as possible. For example, if you know the landlord is intending to strip out the air conditioning to accommodate the next tenant then you would argue any such costs to repair/service these should be deducted.
Most commercial leases of more than 5 years in term will include rent review provisions. In a standard commercial lease these will enable the landlord to either keep the rent at it’s then current level or increase it where the rental values have shifted upwards to the market rent.
Budgeting considerations here would be to think about whether you want the ability to break the lease should you expect a high increase in rent at review. If so then you should also consider including a break clause at or just before any rent reviews and agreeing an additional rent free period to apply if you do not exercise your break right.
Other considerations are to agree a fixed uplift rather than a review or a cap on the rent at review so you know it can never go above a certain level.
Some tenants prefer to agree a review based on the RPI or CPI increase over a fixed period and this will obviously also be determined by the economy rather than market performance.
As mentioned above you can benefit from a break clause but also be wary as landlords will sometimes insist that a break can only be exercised by you on payment of a premium. This is best avoided if possible.
Your lease will usually require you to comply with all statutes including the planning laws. Be particularly wary where you need to make alterations or change the use of the premises as these could require planning permission and this cost will fall to you as will the cost of you seeking the landlord’s approval to any such applications. If a change of use or alteration is required for you to operate then you could insist that the landlord obtains this for you as part of the lease process, at their cost or alternatively they may be prepared to contribute to your costs in this regard.
Fit out costs
It is likely that you will need to carry out some initial works to the property before you can occupy it. Often the landlord will be prepared to compensate you for these costs and period of non-trading by offering a rent free period. Make sure this is adequate for your purposes. Sometimes the landlord will also compensate you for any works that the landlord should have carried out to the premises but instead you will do as part of your initial fit out.
Operators can overlook rates because they instead focus on the rent they will be paying. Often (before any reliefs are considered) the business rates can amount to as much as an additional 50% of the rent the tenant is paying under their lease. Rates can be appealed and there are also several reliefs that can be obtained to reduce the rates liability. It is therefore important you fully understand this often complex system.
Under your lease, you are likely to be responsible for any costs the landlord incurs relating to your requests for their consent to planning changes, alterations to the property, signage installation, or proposed underletting or assignment of the lease. These costs can also extend to the landlord’s advisers including their lawyers, property and management agents and surveyors. It is key that these are limited in the lease to “reasonable and proper” fees and furthermore that the landlord cannot unreasonably withhold or delay any such consent.
On a practical level it is always advisable to try and have a good relationship with your landlord as this should hopefully follow through in them only charging what is reasonable.
Employees and Utilities
If you employ staff you will need to cover any benefits and employer tax contributions, as well as sick pay and maternity leave and the additional cost of hiring replacement staff as and when required. The lease will usually require you to insure for public liability and any third-party liability including your staff. Taking out professional indemnity employment insurance may need to be considered to save potential costs in the long run.
Energy is the second highest controllable cost for commercial premises, after labour. It may seem obvious but is needs to be budgeted for accurately and managed effectively. Much like domestic energy it is always advisable to shop around to ensure you keep these costs down as much as possible.
The above touches on some of the main (often overlooked) costs considerations when you take on a lease of a commercial premises.