A Guide to Lease Regearing

Whilst the commercial property market appears to be on the up it is clear that the market is not as buoyant as it was back in the early noughties. There is also the added uncertainty of a hung parliament and Brexit looming large.

Tenants are still seeking to minimise cost, not only for effective business management but in many cases to ensure their survival through what are still tough times. This has led to landlords and investors alike being forced to review and manage their property assets more carefully to ensure a steady income stream is maintained.

In an effort to reach a commercial balance landlords and tenants are striking arrangements that help both parties to satisfy their ongoing short-term and long-term needs: lease re-gearing.

As you would expect lease re-gearing is primarily dependent on the bargaining position of the parties. If the covenant strength of the tenant is extremely strong and backed up by sound guarantees and a rent deposit then the landlord may not be willing to vary the existing lease at all. However, in a lot of other cases, the landlord may be willing to negotiate, especially if the lease is nearing the end of its term or there is a break date is imminent.

Lease re-gearing arrangements normally involve varying the terms of the existing lease. Whilst not an exhaustive list, the most common variations that arise as a result of re-gearing are:-

Rent review provisions

When the market was at its peak it was common practice for the rent review clause to be open market and upwards only. Many tenants are now asking their landlord if they will agree to vary the rent review clause to a fixed or index linked increase. This gives the tenant the opportunity to budget for future rental liability and removes the unpalatable prospect of an unfavourable rent review. A deed of variation would be the normal way to vary the rent review provisions. However, it may be the case that instead of a deed of variation a reversionary lease will be entered into (see below) or the parties will agree to surrender the existing lease and a new lease will be granted which will include the new rent review provisions and any other new terms that may be negotiated and agreed between the parties.

Rent reduction

If the tenant has an option to break or is at risk of going into administration then the landlord may entertain a reduction in the passing rent to keep the tenant in occupation or to keep the tenant trading. The landlord is less likely to accept this if the directors of the tenant company have given personal guarantees. However, faced with the prospect of no tenant at all coupled with liability for empty property business rates the landlord may be willing to accept a reduction in the passing rent to keep the tenant in occupation.

The landlord may also allow the tenant to pay the rent monthly instead of quarterly, aiding the tenant’s cashflow. This arrangement can be recorded by means of a simple, tailored side letter from the landlord to the tenant.

Extending the term

An extension to the length of the lease term is often of interest to commercial property owners as this can help to improve the capital values of their properties. An extension to the term can also be beneficial to the tenant who may require long-term security and have goodwill inherent in the location of the premises. The landlord and the tenant can enter into a future lease which will come into effect when the existing lease expires; this is known as a reversionary lease. The reversionary lease will normally be based substantially on the terms of the existing lease. However, in today’s market, the tenant may be able to agree secure more favourable terms or added incentives such as multiple options to break the lease. Tenant’s please note that an agreement for a reversionary lease can in some cases be used to delay the payment of stamp duty land tax.

Underletting restrictions

Many commercial leases allow the tenant to underlet the demised premises subject to complying with certain requirements. One common requirement is that the tenant must underlet at the higher of the open market and the passing rent, this often makes it very difficult for the tenant to find an undertenant. Again faced with the prospect of no tenant at all the landlord may accept a variation to the lease to allow the tenant to underlet at a reduced rent. The tenant would be liable for paying the landlord the difference between the passing rent and the rent payable under the underlease.

Although many leases allow the tenant to underlet the whole of the demised premises many leases have a blanket restriction against any underletting of part. If the tenant no longer requires the whole of the space then it makes sound commercial sense to let an area to a third party. The landlord may agree to vary the lease to allow underletting of part if it means that the whole of the premises will continue to remain occupied.

In the current economic climate re-gearing is a good way of helping both the landlord and the tenant achieve their requirements. There are countless ways of re-gearing to suit specific circumstances and in considering the issues in detail at the outset, the landlord and the tenant should be able to reach a mutually acceptable agreement quickly and effectively.

For more information regarding lease regearing, contact Eliot at nexa law on 01691 655060.