It’s a popular misconception that leasing a commercial property is one of the most straightforward aspects of business ownership. After all, it’s simply a case of identifying a site, negotiating the rent and taking up occupancy – what could possibly go wrong? In reality, however, the process is much more complicated and involves considerations that can have far-reaching implications for business growth. Decisions made during the ‘procurement’ process can mean the difference between an acquisition that adds value and one that adds cost.
The dynamics of commercial real estate are underscored by complex relationships, often with multiple stakeholders. Standard landlord and tenant relations can be complicated by the disruptive involvement of investors, management organisations, third-party agencies and other tenants. Maintaining control in such a crowded environment, where each party has its own distinct self-interest, is challenging, but imperative.
When things go sour, property litigation offers the last bastion of hope – but for the central protagonists, the stakes are high. If you’re a landlord, a costly dispute may affect your investment. If you’re a tenant, it could affect your livelihood. With no upper limit on your exposure if you fall into any of the common commercial property pitfalls, as well as huge variability and unpredictability in court rulings, the cost of myopic decision-making can easily exceed the price of your premises. It therefore pays to maintain 20:20 vision.
The most sensible approach is to mitigate the risk of legal action, and limit your exposure through the term of your tenancy, by seeking proactive advice.
Office politics
Despite the sense of seeking specialist advice, organisations can often be too quick to accept the myth that acquiring commercial property is a simple process. Many limit their legal reflection to the simple scrutiny of tenancy agreements – and fail to assess the exposure to risk inherent in some of the more, to the untrained eye, straight-forward areas of the agreement. It’s no surprise that the incidence of commercial property litigation remains both high and frequent.
A site for sore eyes
The potential bear-traps are ever-present, but many can be negotiated away at the start of any tenancy agreement by adopting a pragmatic and considered approach.
So what are the pitfalls? One of the most common mistakes is the tendency for organisations to wait until they’ve all but agreed a deal with a landlord before seeking professional advice. Starting the discussion in the wrong place can be damaging; negotiations may have focused solely on price and critical aspects may have been overlooked. At a basic level, organisations can end up paying too much rent. More damagingly, their inexperience can lead to them paying the far higher price of failure further down the line.
Optimal negotiations will go well beyond the rent – there are numerous additional considerations. How much rent-free period can you negotiate to allow you to move in and fit the premises to your specific requirements? Is there a service charge, and if so, is there potential for capping or limiting it? For example, it’s important to try to negotiate limitations on your responsibility for repair; well-presented site décor may be masking a multitude of sins that could prove costly later in a tenancy. The cost of engaging a surveyor – often charged by reference to the first year’s rent – to negotiate heads of terms against the background of inspecting the premises could save a fortune over the course of a five-year lease.
Dilapidations are a classic cause of anxiety. A property could, for example, be a listed building with a lead roof that becomes beyond reasonable repair and needs replacing. A landlord will undoubtedly want to pass those repair costs onto a tenant. Although there will be a number of get-outs, the cost of finding them – reactively – will not be insignificant. Recriminations around ‘failure to repair’ at the end of a term, though common, are best avoided. Negotiating a cap on dilapidations is the most sensible approach.
Sometimes disputes can appear to be outside of a tenant’s control – not least in multi-tenanted premises. For example, taking an assignment on premises that already have tenants in occupation of other parts of the building is not uncommon. However, in some cases, organisations can find themselves indirectly exposed if their agreement stipulates vacant possession of the whole building at the end of the term. In such cases, even parking spaces can present a challenge; in instances where someone has innocently forgotten an imminent lease expiry and parked overnight, a tenant can face legitimate arguments about whether vacant possession has actually been delivered up.
The importance of building flexibility into lease assignments cannot be overstated. Organisations should avoid agreements that commit them for lengthy periods of time and, where appropriate, negotiate short-term leases or break clauses. Likewise, businesses should beware of contracts that are too difficult to exit; disposing of a property is as important as acquiring one – and it’s vital to establish sensible exit terms up front.
The proactive approach provides much-needed certainty and helps financial planning. The most effective organisations are those that have a good understanding of the long-term costs of tenancy, and how they are likely to increase during the course of their occupation.
This combination of clarity and elasticity enables business to prepare not only for when things go wrong, but also for when they go right. Contractual flexibility gives organisations the agility to expand through growth, or to downsize at times of heightened pressure.
The casual notion that commercial property is one of the most straightforward aspects of business ownership is not only a myth, it’s a lie. The smartest organisations are not those that try to be clever by doing it alone, but those that acknowledge its many pitfalls and partner with a trusted adviser to ensure they avoid them. Theirs is a wise investment. The alternative could be far more costly than they ever imagined.
About the author
Michael Larcombe is a partner and practice leader of the commercial property team at BP Collins LLP.
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