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What are heads of terms for a commercial lease?
Heads of Terms is a list of agreed items between a landlord and a tenant. They are often referred to as the commercial terms. They can be just one page (and they really should be) but some heads of terms can run to 20 pages if the landlord likes to do this.
Are heads of terms legally binding?
No they are not. They should still be taken seriously as parties often don’t want to change heads after they have been agreed. So a tenant should not agree a rent of £80 per square foot if they plan on negotiating it down at the last minute similar to gazundering in residential properties. A landlord would see that as bad faith and certainly pull out.
What should go into a heads of terms document for a commercial lease?
Rent
This may seem obvious but this is the main price of the lease. Rent can either be put as a whole amount – eg £85,000 per annum, or it can be put per square foot (psf). If it is put as per square foot then you will need someone to measure the square footage.
Term
How long will your lease be? Each tenant and each landlord will have a differing view on how long a lease should be. Whilst virtually every tenant would want a lower rent, and a landlord a higher rent, the same cannot be said for how long the lease should be.
A tenant may want a lease for 10 years because he is starting a business selling branded water bottles and he thinks it will take at least 5 years to build up his business.
A landlord may want a tenant to take a lease for only 3 years because she plans to redevelop her property in 3 years’ time.
There are some important things to bear in mind when it comes to term:
- The longer the term the more a Tenant will pay on Stamp Duty Land Tax
- If the term is longer than 7 years the Tenant is legally required to register their lease at the Land Registry. This involves more cost for the Tenant.
- The longer the term, the more likely it is for a Tenant to get a better rent free. (If the landlord knows the tenant is around for longer he may be willing to give a bigger discount.)
Rent Deposit
Landlords normally want security for rent in case the tenant can’t pay. Rent deposits are usually phrased around how many months’ of rent they cover. They range from 3 to 12 months’ rent, depending on what the landlord thinks of the tenant.
Break Clause
There are 3 ways of getting out of a lease (other than it expiring because the term has finished). You can sell the lease, sublet or you can break if you negotiate a break.
Breaks are very important to tenants and your heads should be clear on any pre-conditions for your break. The fewer pre-conditions, the better for the tenant.
Security of Tenure
Back in the 1950s before Amazon (the shop not the forest) and Apple (the computer company not the fruit) retailers sold goods in shops.
They would build up a presence on the high street and when their lease ran out a naughty landlord would step in and take all their goodwill. The government stepped in and drafted the exciting sounding Landlord and Tenant Act 1954.
This gave tenants the right to a new lease at the end of their existing lease. (Landlords could still kick out tenants if they behaved badly and if they wanted to develop but they had to pay compensation to the tenants if they wanted to develop.)
Given the landlords have to pay compensation to remove tenants they are often keen that tenants be “outside the 1954 Act”. All this means is that the tenant does not get the right to a new lease (or compensation). As a general rule an office tenant does not need this right (as they don’t rely on passing trade) but a retail tenant probably needs the right. That said, given online commerce there are plenty who debate the benefits of the 1954 Act even for retailers, but that is for another scintillating blog.
Rent Review
If the lease is 10 years long it wouldn’t seem right for the rent to be the same for 10 years!
In year 5 the rent is “reviewed”. That usually means it goes up. Rent reviews are either based on comparables nearby (what the shop next door to you is paying) (this is known as open market rent) or based on simple inflation. It is impossible to know which method will produce a higher rent 5 years beforehand.
The Property
It seems quite far down the list to only now be talking about the property.
There are 2 main types of property when it comes to a lease. Either you take an “internal shell” or the whole building.
For a tenant there are advantages and disadvantages of each type. If a tenant takes an internal shell they are only responsible for the repair on the inside. If a tenant takes the whole building they are responsible for the outside including the roof. The roof could need a lot of repairs which would be very expensive.
Taking an internal shell may seem better but the tenant may be charged lots of service charge. If the tenant takes the whole building, including the roof, they have more control over costs if a repair is required to the outside.
Repair
This is often misunderstood. Agents talk about an “FRI lease”. FRI stands for Fully Repairing and Insuring Lease. That may be even more vague…
Full repair is generally a bad thing for tenants. It means that you must make the property look perfect – even if it looks like a dive when you take it. If it is in a bad state when a tenant takes the property they should be asking for a “schedule of condition”.
The best way of describing a schedule of condition is this:
You rent a car. Just before you drive off you walk round the car noting all the scratches the previous guy made and you get a sheet of paper showing that. It is in your interest to make sure every scratch is noted down. If it isn’t then the car rental place will say you did it when you give it back to them. That is a schedule of condition! It shows the bad things in a property so a tenant can prove to the landlord that they shouldn’t need to repair them.
Service Charge
Most buildings have a service charge. You should find out what that is running at. If you are a tenant you may ask for a cap so you know where you stand.
Other bits
There are lots of extras which can go into heads of terms.
Tenants can be offered a capital contribution to induce them into the lease.
In an office a tenant can be offered privileges to use showers and bike racks.
If a tenant is going into an office make sure you have internet connection – you might need a wayleave so it is best to think about this early on.
Do I need a lawyer for heads of terms?
No you don’t, but sometimes it helps. We often get involved in looking at heads of terms for clients because it is better to have some things cleared up first, before you get into legals.
There are some very good commercial agents who can help both landlords and tenants get the best deal. Some tenants think they don’t need a commercial agent to help them but that can be short sighted. Some commercial agents really understand their market and can tell you what is a good deal and what isn’t.
What happens after heads of terms?
That is when you need a lawyer. After heads of terms a landlord’s lawyer will produce several documents much larger than the heads of terms – a lease, a licence for alterations, a rent deposit deed, an agreement for lease and maybe more.
Why do you need a lease if you have heads of terms?
Lawyers need something to do so they have made sure commercial leases are much longer than heads of terms. Leases cover more details. Heads of terms may say that you can sell a lease but the lease will contain details on who you can sell to and what you need to do to make it happen.
Can you help me further?
We are always happy to assist in all your commercial lease needs. We regularly act for landlords and tenants in all sorts of places. We understand office leases and retail leases. We also act in industrial areas, franchises and more.
Please do not hesitate to contact Robert Rosenberg at BBS Law for a conversation so we can help you further.
- Email – RRosenberg@bbslaw.co.uk
- Call – 0208 349 5504
