Alternative rent structures in commercial leases
The key priority for a landlord of commercial property is to secure a reliable and predictable rental income, which can be reviewed at regular intervals so that it keeps pace with other property in the market.
Traditionally, commercial tenants have paid rent in advance in four quarterly instalments, with rent reviews every three to five years. COVID-19 has placed increasing financial pressure on business tenants, and many are asking landlords to help cash flow by considering alternative ways to structure the rent.
“The way businesses occupy property is having to change, so the way landlords charge rent needs to change as well,” says Charlotte Vallins commercial property solicitor at Ashtons, “landlords need tenants in their properties, paying rent, so it is in everyone’s interest to structure the rent in a way that reduces day-to-day pressure on the tenant’s business.”
There are a number of alternatives to the traditional structure, depending on the nature of the tenant’s business and the landlord’s long-term plans for the property. Your solicitor will help you identify which will work best in your specific situation.
The simplest alternative is monthly rent payments. The parties may agree to this from the outset, or it may be something the landlord offers on a temporary basis, to get the tenant through this difficult period. It can also be useful in the early days of a business startup.
Landlords of flexible space are likely to have built their investment model around monthly payments, but for landlords who are used to quarterly rent, a switch to monthly payments can be more difficult. If a landlord has finance secured on the property, they may need to get the lender’s consent before agreeing to any change in the way rent is paid.
The landlord and tenant must both be clear about whether rent will be paid monthly throughout the term of the lease or if it is a temporary concession. It is vital that any change or relaxation of the lease terms is documented properly, so the landlord can go back to quarterly rent when expected.
Retail tenants are increasingly asking for their rent to be based on their turnover. Typically, there will be a fixed minimum rent with an additional payment calculated as an agreed proportion of the tenant’s turnover, so they will pay less in difficult years. This arrangement means the landlord takes on some of the risk of a retail business in a challenging trading environment, although this is set against the risk that a tenant with unsustainable rent will just go to the wall, leaving the property empty.
Turnover rent provisions in leases are complex and must be drafted carefully. They can only work if the tenant is able to produce timely and accurate trading figures and share them with the landlord.
One of the biggest issues is working out what goes into the turnover calculation. This is particularly difficult where a business operates online as well as from physical premises. The landlord may argue for a cut of online sales, on the basis that they may be generated by visits to the physical shop. Your solicitor should be able to help you agree with a way to measure turnover and ensure that the lease is clear.
If the lease is for a period of longer than a year, the landlord will want the ability to increase the rent. A common approach is to link the rent to official inflation indices. Many leases still refer to the retail price index (RPI), although the Government has largely moved to a consumer price index (CPI), which is typically slightly lower.
Index-linked rent sounds simple but there are some issues for the parties to decide. Landlords often want a minimum increase (referred to as a collar), while tenants will want a maximum (a cap).
The lease drafting should allow the parties to choose a different index if the one they start with is no longer published or the way it is calculated changes significantly. This is particularly important if the parties choose RPI because it is likely to be phased out over the next 10 years or so.
The way rent is paid can make or break a tenant’s business in difficult economic times, so it is something landlords cannot afford to ignore. If the parties are willing to be flexible and cooperative, there are plenty of ways to give the tenant’s business the best chance, while the landlord still gets a regular income.
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