Lease Length, Break Clauses and Rent Reviews

When you are looking for a business premises you may be keen to simply sign on the dotted line and get a contract in place. However, things often take longer to sort out than you expect, and it is really important to think ahead before you agree your lease and consider these three things: lease length, break clauses and rent reviews.

In any business, things change. You may find that you need to look for alternative or bigger premises sooner than you thought. So, make sure you (and your legal and surveying advisors) have looked closely at these three things in your lease.

Lease Length

In any lease that you are going to sign you should clearly understand:

• The length of the lease: this is also called the lease “term”. Leases can be of any length up to 999 years, but three years is the most common length of lease. Some leases do not have a fixed “term” but are “periodic”. The “period” is usually six months but might be monthly, quarterly or even yearly. Periodic leases continue until either the landlord or tenant takes action to end them.
• Whether there are any rights to “break” the lease: see below under “Break Clauses”.
• Whether you will be entitled to an extension (usually called a “lease renewal”) of the lease when it ends.

This is VERY important. Some leases are protected by a law called the Landlord and Tenant Act Part II. This is a very important piece of legislation that you should know about if you are signing a lease. Leases that are protected by that law are described in a number of ways. Sometimes they are called “inside the Act”, or “protected” leases, or “renewable leases”, or leases with “security of tenure.” You need to know if your lease is one of these or not. If it is, then you will probably be entitled to a lease extension – or more accurately a new lease or “lease renewal”.

Alternatively, of you have a protected lease, you may be entitled to compensation if you have to give it up. This area of law is complicated and so we recommend that you look at our “How To Guide” on it, “The Landlord and Tenant Relationship”. We also recommend that you seek specialist legal advice.

Top Tips on Lease Length

• Understand the difference between a renewable lease and a non-renewable lease (and read the “How To Guide” about it).
• Make sure that the length of the lease is appropriate for your business needs.
• If you are signing a new lease, ask the Landlord to offer you a break option exercisable only by the tenant to give you the opportunity to cancel the lease at a time that suits your business.

Break clauses

This is a clause in the lease which allows either you as the tenant or your landlord, (or both of you!) the right to terminate the lease early. For example, this might be on the third anniversary of the lease start date. If there is a break clause, you have to give notice in writing if you want to use it (or “exercise the break”). This will “break” the lease, meaning that it comes to an end. There are often arguments between landlords and tenants about whether or not a break notice is legally binding.

Some break clauses have conditions that have to be met eg the lease cannot be broken if any rent has not been paid.

Any liabilities due after the lease ends (such as dilapidations) are still due if it is ended (or “broken”) early.

Top Tips on Break Clauses

• Any right to break you negotiate should allow you to walk away from the lease at a given time after informing the landlord in writing. Ideally, from your point of view as a tenant, this should have as few conditions on it as possible, and preferably none.
• Many landlords will try to insist that you can only use your break clause to end the lease on certain conditions. For example the lease might say that you cannot break the lease unless you have paid the rent due under the lease, complied with all repairing obligations, and given up vacant occupation of the property, leaving behind no continuing subleases. Try to keep these conditions to a minimum.
• Make sure you know what those break conditions are, and that you carry them out. That will include things like removing all your belongings and handing over keys, security codes for alarm systems, and so on. If you don’t, then you may still be liable for the rent!
• Watch out when agreeing your lease that the lease specifies that the landlord has to pay you back ‘overpaid’ rent. For example, you might break your lease so it ends on 1 April, but you have to pay three months’ rent on 25 March up to 24 June. If the lease does not say that the landlord has to pay you back the rent for 2 April to 24 June, then legally they can keep it!

Rent reviews

Rent review is another area of law that can be complicated. We recommend that you also read our How To Guide to Landlord and Tenant Arbitration.

Most leases have a “rent review clause” where the rent is ‘adjusted’ or ‘reviewed’ after a set period of time. The lease will set out when and how this is to be done. The idea is that the landlord keeps on getting the “market rent” for the property. As you would expect, rent reviews are unpopular with tenants.

The lease will say how the new rent is to be worked out, and the legal process involved. Leases are different, but a typical rent review clause will say:

• Landlord must serve written notice (by letter) after a certain date saying what they think the new rent should be.
• Tenant must respond by a deadline (usually 28 days) by letter (not by email), or lose, and be stuck with the landlords’ new rent.
• If the Tenant does respond in time, the parties must try to agree a new rent
• If they cannot agree, a third party will be appointed to decide the new rent. This will usually be an “arbitrator”. The lease will say who this is and how they are chosen. Normally this will be a surveyor from the RICS who is qualified to act as an arbitrator, or it might be the RICS Small Business Scheme for Rent Reviews.
• Both parties will get the chance to put their case to the third party or Arbitrator.
• Assumptions and disregards: the lease will set out what factors should be assumed – and what should be ignored – in the rent review. Usually the rent review will assume that the property is in good repair (even if it is not). This favours the landlord. However, other things may favour the tenant. Many rent review clauses disregard improvements made by tenants, for example.

How does the third party or Arbitrator decide?

In most leases, the rent review will be “upwards only open market”, or words like that. This means it is calculated on the basis of an “open market rent”, but if the market rent has gone down, the rent payable will stay the same. Of course, the landlord and the tenant may have different ideas about what the market rent – the going rate – really is!

An arbitrator is normally a surveyor who is qualified to hear both sides’ arguments and decide what the new rent should be. To do so they will look at “comparable evidence”. These are rents for similar properties. It is up to you or your advisors to get this evidence. Don’t expect the landlord or the arbitrator to do it for you!

Comparable evidence, according to the RICS, should be comprehensive – look at lots of rentals not just one or two, as similar as possible to the property being valued, recent, verified arms’ length open market transactions, and consistent with local market practice. In other words, the going rate.

The problem is finding out what the going rate is. It isn’t always easy, but there are a number of ways. Local agents will know what the local market is like. Rent review surveyors can get access to specialist databases and evidence. Another way is to speak to nearby tenants. They have an interest in you not moving in and paying over the odds: if you do, that will be used against them at their next rent review.

A ‘review’ of the rent will also take place when a lease is renewed under the Landlord and Tenant Act 1954. Those ‘statutory’ rent reviews, unlike contractual rent reviews, can be upwards or downwards. These are a lot more tenant friendly and if that option is open to you, it is worth considering.

Top Tips: Things to look out for in your rent review clauses

When you are reading through your lease, make sure that you check that the rent review clause sets out the following:

• When each rent review will take place: it is really important to know when the rent review will happen because it usually means a rent rise, sooner or later, and you will need to plan for that. Just as important, you need to be on the lookout for the landlords’ rent review notice when it comes!
• The method of review: it is really important that you are clear on how this will Usually this is going to be by a written notice (just a letter) from the landlord or their agent, surveyor or solicitor. You need to keep your address up to date. Don’t miss the landlord’s rent review notice.
• Assumptions and disregards to be made when valuing the premises for the purpose of the rent review: be aware of what these are and don’t let the landlord charge you for anything that should be “disregarded”! If you have carried out improvements, make sure that you can prove you were allowed to do them.

DISCLAIMER This information is meant as a starting point only. While all reasonable efforts have been made, the publisher makes no warranties that the information is accurate and up-to-date and will not be responsible for any errors or omissions in the information nor any consequences of any errors or omissions. Professional advice should be sought where appropriate.