Commercial Property: An Overview For Those Looking To Buy A Business
The information contained within this document is intended for guidance purposes only. It is strongly recommended that any party thinking of buying a freehold or taking on a new or existing lease seek professional advice from a qualified solicitor.
In England, Wales and Northern Ireland, technically all land is held by the Crown; everyone else enjoys the right of ownership and possession by virtue of the Crown!
Legally, land can be held in 3 main ways:-
- Freehold
- Leasehold
- Commonhold
Most people will be familiar with the first two forms of ownership, but Commonhold is a relatively new system that allows a number of units to share a freehold, for example a mixed development of commercial and residential units. Until recently, such developments needed to have leasehold units.
Freehold
The freehold of a property is the outright ownership of it. This means that technically it is yours to sell, let, alter or demolish (subject to planning permission etc.) Owning the freehold is a relatively good way to predict the costs of occupation (leasehold rents can vary dramatically, but please note that if you are borrowing the money, so too can interest rates!)
Although buying the freehold is the most expensive option, it allows more freedom, certainty and control, releases you from rent reviews (but not interest rate hikes!). Over the long-term, the freehold is likely to rise in value, providing you with an asset that may appreciate independently of the business within.
From the perspective of an exit strategy (i.e. when you come to sell on the business) owning the freehold provides you with more flexibility and options i.e. you can sell on the freehold or you can become a landlord and lease it. It also simplifies the process – i.e. there is no 3rd party landlord with their own lawyer and agent to complicate and delay things. 3rd party landlords are by far the most common culprit for delaying or protracting the sale of a business.
Ownership of a freehold can also provide a business owner with more leeway to alter the premises.
On many levels, particularly for small businesses, ownership of a freehold is a very attractive proposition. However, businesses for sale with the associated freehold are generally much rarer than those offered with a lease. It is therefore not advisable to restrict yourself to only consider buying a business where there is also the opportunity to buy the freehold at the same time.
In many cases business owners will be offered the opportunity to buy the freehold at some point in the future.
If you are seeking a primary city centre location, it may also be highly unrealistic for you to buy, but possible even for a first time buyer (with reasonable means) to lease.
Leasehold
A lease (leasehold) is derived from a freehold interest (or another leasehold interest) and generally has two key elements:-
- A fixed duration – i.e. a term
- Exclusive possession – i.e. you do not have to share the building or unit with anyone else are allowed “quiet enjoyment” by the landlord (legal jargon meaning that you have the right to conduct your business during the term of the lease without interference from the landlord so long as you comply with the terms of the lease.)
Modern leases exist for all manner of businesses, and are of particular importance where a property based business is concerned i.e. retail or hospitality. Leases are often the only realistic way of occupying and running a city centre based business (because of the costs of acquisition in real prime sites, the majority of owners may be financial institutions and the purchase of the freeholds in prime positions can often prove to be something of a closed shop.)
Leases can be long and complicated documents and it is recommended that any prospective tenant take professional advice from an expert (lawyer and possibly a local surveyor or commercial property valuer.)
Despite efforts from the Law Society and others, there is no such thing as a standard lease.
A lease essentially gives you the use of the property for an agreed term, for which you pay rent. The greatest advantage of the lease is that you do not have to find the capital to buy the building you do business from. With an investment in a leasehold business you are usually investing predominantly in the business, rather than the bricks and mortar. It may be that taking a lease allows you to use a larger or better placed property than you might otherwise be able to afford. This, in turn, might increase your turnover and improve your cash flow, particularly in the crucial early stages.
Types of leases
Common types of leases are as follows:-
- Non-repairing leases – not very common, primarily found in serviced office accommodation (e.g. Regus see www.regus.co.uk) With these leases the tenant has no responsibility for any repair (external or internal)
- Internal repairing leases (IR leases) – the tenant is only responsible for repairing the internal parts of the unit occupied with external repairs normally the responsibility of the landlord.
- Internal repairing and insuring leases (IRI leases) – the tenant is responsible for upkeep and repairs internally for the areas occupied and are also responsible for arranging and paying for or sometimes just paying for the insurance premium for the building.
- Full repairing and insuring leases (FRI leases) – with this type of lease the full repairing responsibility falls upon the tenant (both internally and externally) as does the responsibility for arranging and paying for the insurance of the building internally and externally.
For both IRI and FRI leases in multi-let buildings, the landlord may retain responsibility for organising the insurance and all repairs, but will claim back all the costs by means of a service charge.
From a commercial perspective, all leases can be a risk, since you are liable to pay the rent whether the business floats or sinks. The more established the business, the less the risk. The less established and unproven the business, the higher the risk. Most modern leases tend to be between 10 and 25 years with rent reviews every 3 or 5 years. Longer leases of say 50 years are more normally ground leases, these tend to carry only a nominal rent, sometimes referred to as a peppercorn rent, and in such cases, the business can usually be valued almost as a freehold.
Longer leases tend to be more saleable and it is easier for you (or someone buying from you) to raise money to buy a relatively long lease (banks will generally only lend money for a business acquisition over the term of the new or existing lease.)
Once you take a lease you may be able to sell your leasehold interest to another tenant. This is called an assignment and be quite a complex process. Some leases contain a prohibition on assignment and most others contain a requirement to obtain the landlord’s prior written consent to an assignment. However you should be aware that you may still be responsible to the landlord if the new tenant fails to meet the terms of the lease. In a situation where you are taking an assignment on an existing lease, always try to see the original lease, which may be on deposit at a bank or solicitors. Pay particular attention to your obligations under the lease – these are called covenants. A covenant might influence further development, restrict use, or affect the operation of your business (type and hours of trade) in some way you may not be able to anticipate. Attached to the lease or in documents supplemental to the lease will be details of the rent reviews, deeds of variation, and authorised alterations.
The most important covenant is, in fact the requirement to pay the rent on due dates. Make sure that you know when the rent is due to be paid and whether it is subject to VAT. Other covenants might cover your obligations to repair and maintain the building, pay rates, to meet a range of statutory requirements (planning, public health, licensing, disability discrimination and environmental) and to leave the property in good order at the end of the lease. The landlord will usually be required to insure the property, although they may be able to reclaim insurance costs from you.
Under the lease a landlord may be able to prepare at various times – often at the end of the lease – what is called a schedule of dilapidations. There are repairs which are necessary and which could be expensive. If you take on a lease, you may find that the landlord can immediately serve a schedule of dilapidations. If you are purchasing a lease, you should check in your negotiations with the current tenant that the cost of any repairs has been reflected in the premium (price) to be paid. A thorough survey should give you the information you need to negotiate from a position of strength.
Under the Landlord and Tennant Act 1954, some tenants of commercial property have a statutory right to renew the lease at the end of the original term. The process is regulated by Part II of the Act and requires the serving of various notices and counter-notices by landlord and tenant. The protection does not apply those who occupy a property under a licence agreement or a tenancy or lease at will.
A tenant’s right to renew may, however, be defeated if the landlord successfully shows any of the following:
- Persistent delay in paying the rent
- The tenant has not maintained the property in accordance with the obligations under the lease
- The tenant has not kept to other obligations within the lease, or the occupation of the property has included breaches of law (e.g. planning regulations)
- The landlord wises to redevelop the property
- The landlord has offered the tenant suitable alternative accommodation
- The landlord wishes to occupy the property
- The tenant has a sub-lease of only part of the property and the landlord can make more money by letting the property as a whole.
Checklist before Entering Into a Lease:
- Is the term of the lease right for you?
- Should you and have you commissioned a full structural survey?
- Have you compared the rental with other similar neighbouring premises?
- Have you taken independent advice on the proposed rental level?
- Is the lease contracted out of the 1954 Landlord and Tenant Act? If the answer is yes, do you fully understand the implications of this?
- Have you checked the frequency of rent reviews?
- Are you comfortable with the procedures within the lease for settling any future disputes (particularly rent reviews?)
- Do you have the right to assign (sub-let) the property? Does this require the landlord’s permission? How quickly is the landlord obliged to assess and respond to a request from you in the future to reassign the lease?
- Do you have any plans to modify the premises in any way – are there any restrictions in the lease that could harm your business?
- Does the lease contain a break clause – landlord only, tenant only or mutual? From your perspective as a tenant, a break clause acts as a get out so that if your business is struggling, you wish to relocate or your circumstances change, or if future rent review produces an unacceptable rental level, you have the right to ‘break’ the lease and relocate or wind up the business.
- Is Stamp Duty Land tax due? Refer to the Lease Stamp Duty Calculator found at:- http://ldcalculator.inlandrevenue.gov.uk/