Short-term leases: Common pitfalls – A tenant’s perspective

Tenants acquiring short-term leases often perceive they are exposed to little risk and focus on the speed of the transaction or the overarching business acquisition. While this is understandable, even a short-term lease could lead to significant financial and operational challenges if overlooked.

Do the lease terms match your future plans?

Whether you are negotiating a new lease from scratch or taking on an existing lease as part of a business acquisition, it is important to ensure the lease terms permit your future plans and address any mismatch early in the negotiations.

Are additional consents or variations required to make the lease suitable for your purposes? These will need to be factored into completion timescales. In respect of quantifiable risks, can a reduction to the purchase price or a rent-free period be negotiated or a warranty given for more unknown liabilities such as planning or environmental risk factors?

If you do not intend to remain at the property but are acquiring it as part of a larger transaction, does the lease permit an early exit? Break clauses are the most common way this would be achieved. Are there payments to be made or conditions to satisfy in order to exit early? If so, consider carefully if they are achievable.

Alternatively, if the property is vital to the operation of the business, ensure that you review whether the landlord is able to terminate the lease early and what your renewal rights will be at the end of the lease term.

Leases will usually permit only one use of the property. Is this broad enough to include all your business needs? Permitted Use under a lease only indicates what the Landlord will allow on their premises. Any licences or planning authorisation required for your desired use are entirely separate and you will need to ensure that nothing in the lease prevents you from making the necessary applications for your intended use, should you need to.

Lease costs

Careful consideration should be given to the cost of the lease obligations both during the term and upon termination. A cost-benefit analysis should be conducted with respect to each potential liability.

Although by no means an exhaustive list, some of the common pitfalls are outlined below.

Repairing Obligations and Dilapidations

Whether the lease is terminated by the exercise of a break option, forfeiture or at the end of the term, the lease will oblige the Tenant to return the property to the landlord in a certain state of repair and condition.

Often, this will include redecoration and sometimes removal of any alterations. This could extend to replacement floors, removal of mezzanines or completely reinstating any refurbishment. Seeking landlord approval to these within a certain notice period prior to the end date is also likely to be required. Being aware of these obligations early can allow for the negotiation of a waiver of costs ahead of time (particularly if the Landlord intends to redevelop rather than relet) and allow you to plan logistically and financially.

At the outset, we recommend involving a professional in order to survey the condition of the property and compare the current state to the state required by the lease. What are the potential costs involved to bring the property to that standard and can steps be taken to exclude your liability for those? It would be rare, for example, for short-term tenants to be required to pay for structural remediation. Dilapidation payments may be due at the end of the lease for damage which pre-exists your own occupation. Likely costs should be quantified and accounted for in negotiations.

Pre-existing or future liabilities

It is also essential to make enquiries with the owner or current occupier regarding payments to be made or potential liabilities under the lease. Examples include:

• ensuring there are no rent arrears for which you will become responsible
• ensuring are the service charge payments up to date and the estimates are accurate and manageable.

Don’t forget the tax!

We always recommend that an accountant or tax specialist reviews the lease dealings to ensure all SDLT is paid and accounted for.

A particular issue to be alert to is the likelihood the lease will be “holding over” i.e. the tenant allowed to continue in occupation beyond the original term. This differs from a new lease being negotiated but can often be missed. In such circumstances, additional “hold over” time could give rise to an additional Stamp Duty Land Tax liability for which the Tenant is responsible for notifying HMRC.

While short-term leases may be the more attractive option in terms of cost commitment and undoubtedly be better suited to certain business models, they can still pose significant risks if not negotiated properly. Nevertheless, thorough due diligence and an understanding of the potential liabilities at an early stage allows for measures to be put in place to protect the investment and ensure a smooth transition to a new premises.

Contact our commercial property solicitors today

If you need legal assistance in relation to your business, please do not hesitate to get in touch with a member of our Commercial Property team or complete this online enquiry form, and we will be happy to assist you with your enquiry.