THE MARSHALL & GALPIN GUIDE TO COMMERCIAL PROPERTY
GENERAL NOTES
The following notes you may find of assistance in connection with the acquisition of commercial property whether on a freehold or leasehold basis. They are not intended to be a definitive statement of the law but will provide assistance and point you in the right direction.
1. Instructions
Any transaction starts off by instructions to your solicitors. These quite frequently come from the agents who are dealing with the property. Your own solicitor does however need confirmation of those instructions and it is most definitely advisable to speak to your solicitor before agreeing any terms. We have experience as to the current state of the property market and we can also guide you along the right lines before the Heads of Terms are prepared. We can also indicate whether any of the proposed terms of the deal are likely to cause you considerable expense or considerable difficulty.
Conclusion
Instruct your solicitor at the earliest possible moment.
2. Landlord's requirements for leasehold properties
(a) All landlords will require tenants to produce references. Normally they would require a bank reference (there is now a standard form on which this can be supplied but it does need written authority), two trade references, an accountant's reference and either a personal or solicitor's reference. If you have taken a Lease before, they may require a reference from your previous Landlord. Be prepared to provide these details at the start of the transaction.
(b) Rent Deposits - Where landlords are not satisfied with the references that are being produced or because they feel that they will have greater security they may request a rent deposit. As a tenant there are a number of ways in which you can lessen the blow of this. There will have to be negotiations about how much the rent deposit is going to be, how long it is held for, what happens if you assign the premises in the meantime etc. It is normally dealt with by the tenant providing a sum of money in cash on completion which the landlord's solicitors hold in a designated account.
(c) If the property is being acquired by a company or possibly by an individual who has no trading record a supplement to a rent deposit is for an individual to enter into a guarantee as part of the lease. By and large this is to be avoided because that will render the person concerned personally liable for the terms of the lease and the person concerned can be compelled to take over the lease if the company goes into liquidation. It can bring that person's own assets into jeopardy as a result of the failure of the company.
NB With regard to both points a and c you must obviously know what name the lease is going to be purchased in for the landlord to take up the correct references. Subsequent change of name can cause delays.
3. Procedures
As a very rough guide, once instructions are obtained to enable your solicitor to progress matters we will need the name of the solicitors who are acting for the seller of the property or the landlord. It is the seller/landlord's solicitor who produces the lease/contract for the sale of the property and prior to the signature of the lease or the contract it is up to the purchaser/his solicitors to carry out the necessary searches and enquiries and to satisfy himself that all aspects relating to the proposed acquisition are satisfactory. In the case of a lease (unless there is a business being sold as well) there is not usually a contract and once all the terms of the lease are agreed it is then signed and the monies handed over. In the case of the acquisition of a property freehold there is nearly always a contract and there is a period between contracts being signed and completion.
4. Matters to be dealt with in anticipation of the contract papers
(a) Whether the property that is being acquired is leasehold or freehold one of the most important aspects of the transaction to deal with is a survey. In the case of a freehold you will always be responsible for every aspect relating to the condition of the property and a survey must be carried out to establish that condition. Ideally you want to be spending time running your business not repairing the property! In the case of a leasehold property the repair liability depends upon the negotiations. It is possible to have either:
(i) Full repairing liability – responsible for every part of the property, though with the standard of repair and replacement requirement being dictated by the landlord rather than your own requirements.
(ii) Internal repairs only – usually where you are taking something like a lock up shop rather than the whole of a building. You may still end up with effectively full repairing liability if there is a service charge or a contribution towards common parts. The only difference is that the landlord will carry out the works to the structure of the building and the common parts.
(iii) Decorating liability only – this is quite rare.
If you are acquiring a lease with less than full repairing liability ideally the landlord should in the lease agree to keep the rest of the building in repair. There are some institutional landlords, eg Oxford City Council, who refuse to do this.
If you do have a lease where you not only have internal repairs but also a contribution to the structure any survey should relate obviously to the whole of the building not just the part you are going to be letting.
(b) Searches - it is always advisable for commercial properties to have a local search carried out no matter how long or short the lease might be. The local authority carry in their registers not only details of roads, sewers, planning and the like but also infringements of building regulations approvals and notices served in relation to operations of businesses. Many problems will be planning ones (see below) but there are others which can affect. It is also now recommended that you have an environmental search carried out to try to deal with contaminated land. A search with the Water Authority is frequently appropriate as well.
(c) Planning - the most critical aspect of acquiring any business premises is to ensure that the use to which you intend to put the premises is permitted by the local authority. With leasehold property the situation is rather more complicated because the landlord may wish to impose more restrictive uses than the planning authority would permit, eg the planning use may be A1 retail whereas the lease may say that it can only be used for sale of jewellery. As to what use a tenant might want in a lease will depend upon other tactics with regard to rent review for which see later.
These notes do not permit a comprehensive over view of planning but it will help to specify the basic and most commonly encountered planning uses. These are classified by an alpha numeric system:
A1 Covers retail uses including cold food but not hot food. It also covers other uses such as hairdressing, funeral directors etc
A2 Covers financial and professional services. These are services that would normally be provided in a high street and you normally would require a shop window. Estate Agents and Insurance Brokers, Banks, Building Societies are covered by this.
A3 Covers the sale of hot food (take-aways), restaurants, pubs etc until 21st May 2005. After that date it covers only restaurants and cafes. It is important to establish whether the premises which prior to 2005 had A3 permission have A3, A4 or A5 under new regulations.
A4 As from 21st May 2005 covers pubs and bars
A5 As from 21st May 2005 covers takeaways
B1 Covers offices (other than those fitting into A2) research and development and light industrial. The latter covers businesses which do not cause detriment to the amenities by reason of noise, vibration, smell, fumes, smoke, soot, ash, dust or grit.
B2 Is the general industrial group
B8 Is storage and distribution, ie warehousing
C1 Covers hotels and boarding houses
C2 Covers hospitals and other residential institutions
C3 Covers dwelling houses
D1 Covers doctor's surgeries, museums and other non-residential institutions
D2 Covers cinemas, swimming baths, concert halls etc
There is no class specified for certain types of use the principal of which is the sale of cars or sale of petrol.
Broadly speaking, as long as there are no specific restrictions in any planning permissions, the classification system enables you to use the property for any use within that class without getting planning permission so change from an Estate Agents to a Bank is all within Class A2 and would not require planning permission.
Changing from one class to another nearly always does require planning permission but there are certain changes, e.g. from A3 to A1 which are specifically permitted.
We would stress, however, that this is a general framework, and you cannot automatically assume (even if you intend to put the property to the same use as your predecessor) that you can operate any type of business. There can be restrictions on planning permissions which make the permission personal to a particular person or organisation, there can be restrictions on opening hours, there can be restrictions indicating that it can only be used for a particular use whilst other premises are put to another type of use.
It should also be mentioned that the classification system above has only been with us since 1987. Prior to that there was another classification system and whilst the previous groupings approximated to the current classification they are not exact matches. Prior to 1948, of course, there was no planning control at all. It may not therefore be possible to get a definitive answer, but there is the facility to get the Planning Authority to issue a certificate allowing you to use the premises for what you require.
(d) The Purchase Price - If you are simply taking on a lease, you may not be paying anything to the Landlord at all apart from rent or service charges. If, however, you are buying the freehold or you are not only taking a lease but buying a business or you are acquiring the existing lease and business, there will be aspects to be dealt with relating to the price.
(i) Freehold building alone. The price purely relates to the building but there are occasions when the purchase of a commercial freehold property can attract VAT. This should be specified as part of the original negotiations by the Vendor
(ii) Acquisition of a new lease but no business. VAT can "rear its ugly head" as Landlords can charge VAT on commercial property rents if they wish. If this is likely to affect you this must be covered as part of the original negotiations.
(iii) Acquisition of existing lease. Again there is a possibility that VAT may be charged on any premium for the lease
(iv) Acquisition of a business. The Purchase price will be split between four elements. Firstly, the property whether it be freehold or leasehold. Secondly, the goodwill of the business. Thirdly, the fixtures and fittings of the business which are being sold with the business. Normally such matters as central heating and carpets will form part of the building, but counters, tills, desks will be fixtures and fittings for these purposes. Fourthly, stock which will depend upon the type of business that is carried out. It is strongly advised except in very rare circumstances that no price is agreed for stock at the time of original negotiations (though an indication can be given as to what sort of stock level you are expecting to take over) and that the stock is valued and paid for on the completion date. This ensures that you do not have to take over stock which is out of date or unsaleable, if you do not wish to do so.
Whether you have to pay VAT on any of the four elements, depends by and large upon whether you are acquiring the business from a VAT registered organisation, and whether you are buying the business as a going concern or simply buying certain parts of the business to enable you to operate your own business.
(v) Accountants. Following on from the above, it is always advisable to appoint Accountants at an early stage if you do not have any. We can assist if you need guidance on who to appoint. They should be brought in with regard to the name in which the business is to be bought, assistance in registering for VAT and advice concerning the split of the purchase price. They can also offer valuable assistance in assessing the accounts of the business which you should try and get a look at, at an early stage.
5. General Information
Businesses are beset by a number of regulations with which they must comply. This is not a comprehensive list, but highlights certain areas of difficulty:-
(1) You will have to carry out assessments and comply with fire regulations, and the cost of these can be considerable e.g. fire doors, fire extinguishers, sprinkler systems. It is always advisable to find out what fire arrangements the current owners have.
(2) There are other regulations with which any business must comply e.g. Control of Asbestos, Health and Safety at Work, Office Shops and Railway Premises Act, Disability Discrimination, etc. We can provide further information relating to this.
(3) If your business involves the sale of alcohol (but not for certain wholesale) you will need a premises licence and you will also need a personal license. Licences are granted by the Local Authority. We have a specialist licensing department and we should be informed at an early stage if this is required.
(4) Fixtures - whether the property is freehold or leasehold there will be various systems which need to be checked out.
e.g. Does the property have an alarm system?
How does it work?
Can you take it over?
Who owns it?.
Does the property have any form of heating system - same considerations apply.
Does the property have all the services you need - gas, water, electricity, telephone, computer wiring, three phase electricity? If not, can the services be obtained? Where do they have to come from? Will they come, straight from public services, or do they go across somebody else’s land for which you will need permission?
Are you expecting the telephone system still to be there? or the lighting system? are those partitions part of what you are taking over, or will they suddenly vanish?
6. Lease Terms
Either you will be taking over an existing lease in which case you will be effectively stuck with what has already been agreed, or negotiating your own terms, in which case you have a freer hand to decide what you want. Whether you end up with what you want will depend upon how much the premises are in demand, though if there is no demand for them, why are you taking them on? The following will assist:-
(1) Security - with certain exceptions leases of business premises are covered by the Landlord and Tenant Act 1954 Part II, and that effectively states that no matter what term is agreed in the lease, the lease does not automatically come to an end. It can only be terminated by service of a notice either by the Landlord or the Tenant, and ultimately a Court can be brought in to arbitrate as to whether the Tenant gets a new lease or not, and if so, on what terms.
BUT if at any stage as part of the negotiations, reference is made to the security of the Landlord and Tenant Act being excluded, or the exclusion of Section 24 to 28 of the Landlord and Tenant Act or the tenancy being outside the Act, this means that it is the intention of the Landlord that the Tenant does not have the security of the Landlord and Tenant Act, and when the lease comes to an end - it ends. There is no right to a new lease. If the Landlord is himself a Tenant there may be provisions in his own lease which compel him to operate this procedure. In that case, there is no negotiation. If it is an existing lease and has already been excluded, again there is no negotiation. If it is a new lease, however, it is never to the Tenant's advantage to have the Lease excluded. Not only does it mean that the tenancy automatically comes to an end and a tenant has no right to remain, but it also means that if the Landlord is prepared to allow the Tenant to remain all terms are up for grabs, and there is no independent body which will regulate this. This sort of procedure is often used by Landlords to establish e.g. rent review patterns, if they grant a three year Landlord and Tenant Act excluded lease, it means they have the right to have a new rent after three years.
Assuming that the lease can be negotiated as within the Landlord and Tenant Act or it is an existing lease which is within the Act it is normal for there to be a provision for the Landlord to terminate the lease early for breach - see Landlord's remedies below - but assuming that all parties comply with their obligations the termination procedure is as follows:-
(a) the earliest date on which the lease can be terminated is the end of the term that has been agreed
(b) a Landlord cannot serve notice until the last twelve months of the term, but can serve notice at any time during that last year or beyond the end of the term
(c) the Landlord must give six months notice
(d) the notice has to be in a particular form and must specify whether the Landlord is prepared to agree to a new tenancy
(e) if the Landlord is not prepared to give a new tenancy - he must specify the grounds on which he refuses. These are set out in the Landlord and Tenant Act as follows:-
(i) Disrepair
(ii) Persistent unpunctuality in payment of rent
(iii) Substantial breaches of covenant
(iv) Offer of alternative accommodation
(v) (If it is a sub-tenancy) that letting or disposal of the whole premises would be prejudiced by the existence of a sub-letting
(vi) Intended demolition or reconstruction
(vii) Intended occupation for business purposes or as a resident by the Landlord or related organisation.
It will be seen that some of these grounds relate to how the Tenant operates in the premises and some are based on the Landlords own proposals.
There are also procedures where the Tenant can request a new tenancy, but it is inappropriate to discuss these in detail at this stage. Any prospective Tenant must be aware as to how long their lease is going to be, and what prospects they have of remaining.
(2) The Term of the Lease - For any written lease, the term should be fixed though there can be leases for a fixed period and then terminable on notice. It used to be the case that the longer the term the better, because then the Tenant could borrow on the security of the premises. Since Lending Institutions have effectively stopped lending on leases, this has been more offset by the fact that a Tenant remains liable throughout the term of the lease (see below). The tendency now is for shorter terms or, if it is to be a long term, break clauses - see below.
(3) Rent Reviews - If a lease is longer than three years it is likely that there will be a mechanism to review the rent. The review pattern is normally between three years (when it's a Landlord's market) and five years (when it's a Tenant's market). There are variations to this pattern, and sometimes the rent is index linked. There are a number of factors which affect rent e.g. whether the property is within the Landlord and Tenant Act or not, how restrictive the planning use is, what the repair liability is etc. Rent review clauses are fairly standard, though there are some very fierce ones e.g. Oxford City Council which can be worked by trigger notices and the Tenant runs grave risks of rents being imposed which are uneconomic. In a Tenant's market a Tenant should be looking for the rent both to go up and down, depending upon market forces, whereas a Landlord would almost always want the rent to be the same or higher. It is a matter of negotiation, but even in the recession in the 1990’s very few leases were granted on the basis that rent could go down. There is an alternative form of rent review where increases are limited to the RPI. These have tended to favour tenants.
(4) Service Charges - If the property is part of an industrial estate or similar you are more likely to get service charges than for lock up shops. The service charge can be a substantial sum of money and evidence will be obtained by the Solicitor of the last three years service charges. An indication of the current level of service charge should be obtained before committing yourself to agreeing to take the lease.
(5) Stamp Duty Land Tax – This tax applies just as much to commercial properties as it does to residential properties but there are differing ways in which it is applied. As mentioned there are different elements of the purchase price all or some of which may apply and these are as follows:-
1. The premium for the property or the Lease.
2. The cost of the fixtures and fittings that belong to the Tenant.
3. The cost of the goodwill.
4. The rent that is payable under the Lease.
In any commercial property acquisition any of the above elements can apply in combination. In turn:-
1. The Premium
Stamp Duty Land Tax can be chargeable on the premium. With most commercial transactions the average annual rent means that Stamp Duty may be chargeable on the premium even if it is lower than the current exception limit of £150,000.
2. Fixtures and Fittings belonging to the Tenant are exempt from Stamp Duty Land Tax.
3. Goodwill is exempt from Stamp Duty Land Tax though HHRC are trying to say that what some people classify as goodwill is part of the inherent value of the property and thus chargeable.
4. Rent is chargeable to Stamp Duty Land Tax and any VAT that is payable on the Rent is incorporated within the calculations. In very basic terms to calculate the amount of Stamp Duty Land Tax you have to multiply the Lease term by the highest ascertainable Rent that is chargeable during the first five years but there is an annual discount.
Example: a Lease for ten years at a starting rent of £30,000 with a rent review after five years. Highest ascertainable rent in first five years is £30,000 multiplied by 10 = £300,000 less annual discount of currently 3.5% net present value £249,498 less exemption £150,000, Stamp Duty at 1% on £149,498, total payable £1,494.
You will therefore see that if you reduce the term you pay less Stamp Duty Land Tax and you may not pay any at all if you can get the net present value down to £150,000 or below.
(6) Land Registry – You are now obliged to register Leases which either are granted for a period of seven years or more or which at the time you acquire them have at least seven years left to run. The result is that you will have to pay fees to the Land Registry which are not very large and you will end up with the same Title document for the Lease as you would for a house. It does also have the additional advantage that because your Lease is registered at the Land Registry copies can be obtained. It is not infrequent for shorter term business Leases to go missing. As a Landlord it is a bit of a disadvantage because the Lease gets registered against your Title and when the Lease expires you have to arrange for it to be cleared off. The can cost you money.
7. Words of Caution
1. Any Tenant who takes over a lease completed before 1 January 1996 is committing himself to comply with the terms of that lease for the whole of the term of that lease, whether or not he is still in occupation. There are new rules restricting liability for leases signed after 1 January 1996 but a tenant can still be asked to guarantee anyone to whom he lawfully assigns but no-one else thereafter. To protect himself a Tenant should either:-
(a) (in the case of a lease before 1 January 1996) obtain agreement from the Landlord when he disposes of his interest in the property that he is released from any covenants he has entered into
(b) try and get a break clause put in the lease, so that at least whilst he remains liable he can put a limit to his liability
(c) take short leases again for the purposes of limiting liability
2. Be very careful before any programme of work is initiated. You will nearly always require planning permission, building regulations approval and the Landlord's consent. What is more important, however, is that improvements that you make can become fittings as part of the premises, and you will effectively be forced to hand back to the Landlord not only the premises but also the improvements that you have made. There can be circumstances as well, where you do not get any compensation. The shorter the lease, the more wary you should be of carrying out items which require capital expenditure, the benefit of which may end up with the Landlord rather than you.
3. Landlord's Remedies - These are currently the principal remedies:-
(i) if there are arrears of rent - insurance service charges etc, are often classified as rent for this purpose - the Landlord can operate the ancient remedy of distress. All he needs to do is to appoint a certificated bailiff and the bailiff can come onto the premises and remove goods to the value of the rent owed, and dispose of them. This remedy is likely to be abolished very shortly.
(ii) there is normally a provision in the lease which entitles the Landlord to serve a notice requiring works to be carried out to the premises, which if not carried out within a particular period of time can be done by the Landlord and charged out to the Tenant.
(iii) there are nearly always clauses in any lease which entitle the Landlord to take action to forfeit the lease (bring it to an end) if there are rent arrears or the Tenant goes bankrupt or the Tenant goes into liquidation or there are breaches of covenant
(iv) if what is owed to the Landlord is money, it is possible for Landlords to take action in the Courts, simply to recover the money, rather than forfeiting the lease. They may choose to do this where the letting market is not strong.
8. Insurance
There are several aspects of this that have to be dealt with. If the property is bought freehold, all aspects of insurance will be the Tenant's responsibility. If, however, it is leasehold the general provision is as follows:-
(i) the Landlord normally insures the buildings, and that will include anything that is part of the fabric of the building i.e. the heating system (though responsibility for mechanical repair of the heating system is often the Tenant's)
(ii) the Landlord's insurance policy does not normally include any plate glass, and it is normally the Tenant's responsibility
(iii) occupiers liability may be covered by the Landlord's insurance policy, but is more frequently dealt with by the Tenant
(iv) any contents insurance will nearly always be the Tenant's responsibility
(v) any trade insurance i.e. loss of profit, theft, loss of licence is the Tenant's responsibility
(vi) any insurance for loss of rent is normally the Landlord's responsibility
When papers are produced to us, insurance details are sought and the definitive statement can then be made. Regardless of whose responsibility the insurance might be, the Landlord will nearly always ask the Tenant to pay the premiums for any insurance he carries out, and this will either be the whole (in case of the rent or the whole premises) or a proportion if part of the premises is being taken.
For further information please contact:
James Barnatt (Oxford) 01865 268644 email - mailto:james.barnatt@marshallgalpin.com
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