BUILT ENVIRONMENT JOURNAL

Dilapidations strategies to help clients

When economic conditions are tough, surveyors can add significant value for their clients – whether landlord and tenant – by adopting a collaborative approach

Author: Gillian Murray

20 April 2021

Dusty pipes

Build-up of dust on pipes © Gillian Murray

In difficult economic times, robust, strategic support with dilapidations matters can make a weighty difference to our clients' business circumstances. When different chartered surveying specialists work well together, we achieve great dilapidations results for our clients. This article offers some hints and tips that will help surveyors to help clients at each stage of a typical leasehold property cycle.

Tenant contemplates leasing

Different leasing arrangements each have different implications for the tenant's dilapidations liability; for example, taking an assignment differs from taking a sublease. Take time to help your tenant client understand what the implications are, and urge them to assess dilapidations as part of their due diligence.

When the building surveyor and quantity surveyor work closely with the client's legal advisers and agency advisors, clients can better understand how leasing arrangements apply to the premises in practical terms.

Typical leasehold property lifecycle

The resultant advice helps clients build an allowance for any dilapidations liability or risks into their financial models, and once they are in occupation, they can make financial provision for these each year to help reduce their tax bills throughout the course of the lease rather than just at the end.

Tenant takes a lease

While the agent is busy negotiating the lease terms, the building surveyor's experience of applying leases to buildings means they have a good eye for clauses that favour the landlord or the tenant. It might not necessarily be a letting agent, could be an investment agent or another variation of the commercial agency spectrum.

However, surveyors are not – and should not try to be – legal advisers, so take care that you only advise on the application of the lease to the building, not its interpretation. When the building surveyor works together with the agent and understands the client's objectives, that client benefits.

The building surveyor's advice on the merits or otherwise of annexing a schedule of condition to the lease can be useful; this is not always a helpful add-on, and ought not be the default recommendation.

Tenant fits out premises

The tenant's alterations and additions change the context for dilapidations. A licence for alterations for alterations will likely be required, and its obligations will trump those of the lease in respect of the licensed works. The licence obligations must therefore be understood clearly.

The tenant will next need to adjust their annual financial accruals for dilapidations. The building and quantity surveyors can support this with an updated dilapidations assessment. Ideally this assessment would accompany a review of potential fiscal incentives for the tenant's works, including any capital allowances. The surveying team's advice can help the client minimise the overall financial impact of its project works through careful accruals and tax planning.

Sale of premises

A prudent purchaser, perhaps advised by an investment agent, should ensure that yield calculations or values take account of the actual dilapidations at the premises, rather than applying a general rate per square metre or foot.

Take care that the technical due diligence survey does not make sweeping statements that ought to be interrogated in more depth. Some may contain assumptions around the extent of premises demised to the tenant and most will not have read the tenure documents in full. It is important to identify the risks and potential maintenance backlog or prospective capital expenditure shortfalls at the change of a tenancy.

Blockwork

Avoid surprises, not all disrepair or breaches are so obvious

Tenant contemplates relocation

When the tenant begins considering whether to stay or go, particularly where it has a break option, the building surveyor and agency surveyor can create considerable value for their client – whether tenant or landlord – and help them to leverage every advantage in their commercial discussions.

For instance, a full dilapidations assessment prepared by the building surveyor, quantity surveyor will advise whether repairs to equipment will be required at the break date, compared to full replacement becoming necessary by the end of the lease. The tenant's agent might use this knowledge strategically in the lease negotiation, leveraging more favourable terms if their client agrees not to exercise the break.

The agent's advice will also be strategically important when considering potential market conditions at break dates and expiries. Should tenants carry out works themselves? If they do not, are they likely to face a claim for loss of rent under the lease, given that there are a number of prospective tenants keen to move into the premises once vacant?

Claiming dilapidations

Landlord clients can avoid surprises if they have a dilapidations assessment or claim prepared by their surveyors well in advance of the lease expiry. Knowing what to expect and having an ascertained (quantified) claim prepared by experienced dilapidations surveyors is also useful to help the landlord protect itself in the event of tenant default or liquidation.

In these difficult times, maintaining relationships between landlord and tenant can be a crucial part of the negotiator's role. Landlord clients will want to remain on the best of terms with the tenant so they can offer them another unit when the business is of a size that requires relocation. Guide your client, and respond to their guidance on how the relationship ought to be factored into your discussions.

Be transparent with your landlord clients about how their intentions for the property will affect any potential dilapidations claim. Managing their expectations about recovering sums claimed is vital – some degree of commercial compromise is almost always necessary during negotiations.

Ideally, you will provide your client with a range of outcomes - widely known as the zone of potential agreement - for the expected settlement, with best and worst cases at either extreme. Recognising that both parties will try to take advantage of grey areas in the lease can help smooth the negotiation: remember that it's not personal, and you should try not to make it so.

"Landlord clients can avoid surprises if they have a dilapidations assessment or claim prepared by their surveyors well in advance of the lease expiry"
Tenant carries out works

Advise your tenant client to ensure they comply with lease terms. Take care not to do more than the lease requires and have regard to any break clause preconditions, highlighting to your client when they require their legal adviser's input.

The lease - and usually any licence for alterations - will be prescriptive about what permissions or criteria should be in place for works to be considered permitted or licensed. Help clients to understand and secure these permissions and fulfil the letter of the lease requirements.

Have regard to the constraints on the time available to carry out works – does the landlord have to serve notice of its reinstatement requirements? If so, what does the lease say about the extent of the notice? If it says nothing, what might be considered reasonable notice given your jurisdiction?

These considerations will affect the strategies open to the tenant client when carrying out works. They will also affect the landlord client where time is of the essence in serving the notices the lease requires.

A roof truss bolt

A roof truss bolt

Evidencing loss

Landlords are increasingly aware that in most circumstances they will need to evidence any loss associated with the tenant's dilapidations. Guide them through the options available, and ask your valuation and agency colleagues to advise when needed.

Should the landlord carry out works and itemise the cost of these as evidence of loss? Would a diminution valuation or evidence by other means be more appropriate? The surveyor team can set out strategic options and help clarify risks and commercial considerations.

Settlement

As negotiations progress, keep under review the client's best alternatives to no agreement. Does the lease prescribe arbitration, mediation or litigation? What happens if the tenant goes into liquidation? How financially secure is the tenant entity in any event? What are the risks? How important is it to your client that the relationship is maintained?

Once the dilapidations settlement is agreed, advise your client to have their legal advisor draw up or review the agreement terms. It is important that the parties understand whether the agreement covers fully and finally all breaches under the lease or just the dilapidations in the schedule – or whatever the parties intend – and accept this.

"As negotiations progress, keep under review the client's best alternatives to no agreement"
Repeat business

When the landlord moves to re-let the premises or the tenant again faces choices about leasing premises, then the sensible advice you have provided and your collaborative attitude will make you the natural choice to support them in future transactions.

Our clients need chartered surveyors to support them in their strategic decision-making now more than ever. We can help them mitigate risk and make the most of their investments. But to do so effectively, we must work together and think broadly about all the circumstances.

gillian.murray@aecom.com

Related competencies include: Client care, Communication and negotiation, Legal/regulatory compliance

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