A Buyers Guide to Investing in Commercial Property
If you are considering investing in commercial property, then there are a number of factors which need to be considered.
David Stone, a highly experienced commercial property solicitor who specialises in leases and purchases, has created this detailed investment guide for anyone looking to invest in commercial property.
There are two important strands to commercial property investment value which you must be aware of. The first is the actual building itself (the bricks and mortar), the second being the occupational leases you will be taking subject to.
Bricks and mortar
When investing in commercial property, the bricks and mortar element will be very much the domain of your surveyor. They will be able to advise on the state of repair of the property and whether additional expenditure will be required to comply with important aspects such as fire safety, asbestos and disability discrimination legislation.
All of these issues will impact the commercial property’s value and thus the success of your commercial property investment. However, it should be noted that compliance with statutory obligations of this nature should be the responsibility of the tenants, provided the commercial property leases have been properly drafted.
Energy Efficiency in Commercial Property
One aspect unlikely to be covered by any existing occupational leases and should be considered when investing in commercial property, is who should take responsibility for works required to a building where the current level of energy efficiency falls below Band E.
The minimum energy efficiency standards require a commercial landlord to ensure that commercial property meets the said minimum level, failing which a landlord may not grant a new tenancy, extend or renew an existing tenancy, nor continue to let the property.
Validity or enforceability of the lease itself is not affected by a landlord letting or continuing to let the property in breach of minimum standards, but the landlord will be in breach of the relevant regulations and liablei to enforcement action if certain exemptions are not available. Prior to investing in commercial property, you need to be clear as to the likely cost of improvements necessary to satisfy energy efficiency standards.
Occupational lease terms fundamental to value
The next area to consider when investing in commercial property involves who your tenants are and the terms under which they occupy the premises.
It is of course, important to understand the financial strength of your tenants, so you can consider the risk of a tenant defaulting, leaving you potentially with rent arrears, a dilapidated property and no income stream to service your mortgage requirements.
You can then turn your attention to the principal lease terms.
1.0 Rent reviews
The threat of government intervention to enforce upon the market upwards and downwards rent reviews is now increasing but, for the time being, your occupational leases should provide for upwards only rent reviews to protect your commercial property investment.
Rent review provisions should provide a true market rent calculation and any leases that introduce artificial assumptions and disregards, designed to provide rental uplift on review, can sometimes work against a landlord. If draconian or unusual in the market, the tenant could argue for a discount on review based on the lease terms being unreasonable.
2.0 Subletting and assignment
The ability to assign or sublet the property is valuable for the tenant as it provides flexibility should it no longer want the property. Landlords, however, will not want to lose good tenants; hence, properly drafted leases will provide for an ability to assign or sublet to be subject to the landlord’s prior consent, which cannot be unreasonably withheld.
You will want to check that the proposed assignee or subtenant is of sufficient financial standing to comply with the lease terms and pay the rent.
Notwithstanding the above, there is no need for alienation provisions to be overly restrictive as again, onerous provisions imposing unusual restrictions on tenants can have a downward effect on rent review, affecting the value of your commercial property investment.
3.0 Length of commercial lease, break clauses and renewals
The tenant will want the length of lease to be appropriate for its business needs. As such, many leases will contain the tenant’s break rights that allow the tenant to determine the lease at a time that suits. This however, will not be attractive to landlords and, when investing in commercial property, you need to always factor in the risk of tenants exercising break clauses, leaving you with empty premises.
Tenants will want leases to be protected by the Landlord and Tenant Act 1954, providing a statutory right to renew at the end of the term. If the lease is contracted outside of the 1954 Act, the landlord can refuse to grant a new lease at the end of the term and insist on the tenant vacating.
This may not necessarily be what the landlord wants but it could give rise to renewal negotiations stacked in the landlord’s favour. That said, a protected lease is more valuable for a tenant, enabling a landlord to potentially demand a higher rent. A lot will turn on whether a landlord has designs on future redevelopment, where the ability to obtain vacant possession becomes crucial.
4.0 Repairs
When investing in commercial property, landlords will want tenants to be under a full repairing obligation where the tenant is required to keep the property in good repair, thereby including an implied obligation to put it into good repair.
Tenants will want such repairing obligations to be qualified by a photographic schedule of condition, so they are only required to keep the property in no worse condition than when the lease was entered into.
5.0 Alterations and change of use
Changes of use and the carrying out of alterations should always require the commercial landlord’s consent, not to be unreasonably withheld if such alterations are non-structural or such change of use does not potentially affect the value of the premises.
Again, overly restrictive provisions could hurt a landlord on rent review but on the flipside, you do need to be able to impose reasonable control on alterations and use to protect your commercial property investment and retain the attractiveness of the building for other occupiers.
6.0 Insurance
In most cases, the landlord will insure the property with the tenant reimbursing the landlord for insurance premiums. When investing in commercial property, you will want responsibility for maintaining the insurance and dealing with any repairs arising from insured damage.
Problems arise, however, where damage is caused by an uninsured risk and the lease does not satisfactorily cover such an eventuality. Ideally, landlords will want to pass on the unlikely risk of uninsured damage to tenants, but tenants will argue why should they be responsible for the same when the landlord owns the capital interest in the property? The fairest approach is to allow either party to determine the lease in the event of uninsured damage, unless one or the other wishes to carry out the repairs at its own cost.
7.0 Service charges
Where you have multi-let buildings, the likelihood is the tenant will be responsible for the maintenance of the interior parts demised, with the landlord maintaining the structure and exterior and providing other services to the tenants. The cost of providing such services will then be recovered through the service charge.
When investing in commercial property, it is important to ensure there are no service charge qualifications or unreasonable caps which could give rise to a shortfall in the service charge in the event of significant outlay.
GA Solicitors’ commercial property team has years of experience assisting landlords and all those who wish to invest in commercial property. We can work with you to ensure your investment and assets remain protected. Call our solicitors in Plymouth on 01752 203500 or email enquiries@GAsolicitors.com for a clear and friendly discussion.
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