PROPERTY JOURNAL

An A–Z of lease terms for APC

Several APC competencies depend on an understanding of lease terms. What do candidates need to know about this important aspect of tenancies?

Author:

  • Jen Lemen FRICS

31 May 2024

All APC candidates, especially those practising competencies such as Landlord and tenant, Leasing and letting, Property management and Purchase and sale, will need a robust understanding of lease terms.

This means they will need to be able to read, summarise, analyse and – in some cases at level 3 – advise on such terms. They should therefore understand some of the most commonly used terms, and their basic implications for property-related work and advice.

Alienation: an alienation clause recognises that most tenants will require flexibility when deciding to let a property, that is the ability to assign, sublet or share occupation. Assignment is where another party – the assignee – steps into the tenant's – the assignor's – shoes before lease expiry, so that the latter thereby disposes of their leasehold interest in the property. Subletting, in turn, is where the tenant grants a sublease, also known as an underlease, to a subtenant, while remaining an intermediate party through the headlease. Sharing occupation by contrast is usually permitted for companies that are part of the same group as the tenant and no new landlord and tenant relationship is created. The alienation clause in a lease will define the parameters for each of these options; for instance, specifying that a tenant cannot sublet at less than market rent, or that if assigning the lease, they must do so for the whole of the demise rather than just part. 

Break options: another way of providing flexibility to both parties is a break option, a clause allowing one or both parties to terminate the lease before its contractual expiry. Ideally, for clarity, the break date should be a specified date rather than a rolling date or a date based on a formula. The wording of break clauses can be very contentious, however, and needs input from a solicitor at the outset. Generally, written notice is required, for example six months in advance of the break date. Some break options will also include conditions precedent, such as vacant possession, which must be strictly fulfilled for the break to operate successfully. 

Costs: tenants are likely to be liable under a lease for a variety of different costs and outgoings, including rent, business rates, utility costs, service charges and insurance. These may be paid monthly, quarterly or annually depending on the wording of the lease. Tenants must check what needs to be paid and when as well as how the amount is calculated and whether VAT is payable on any sums. 

Related article

An A–Z of the Landlord and Tenant Act 1954 for APC

Read more

Demise: this is the extent of the premises that a tenant has the right to occupy under a lease,  i.e. what they have been granted exclusive possession of. Usually, the lease will include a red-line plan which:

  • can be registered at the Land Registry if over seven years in length
  • accords to the whole or part of the freehold title and confirms the tenant's rights. 

This may also include any rights for services, loading or parking, as well as any ancillary space or separate accommodation.

EPC: under the Minimum Energy Efficiency Standards (MEES), commercial property needs an energy performance certificate (EPC) rating of at least E if it is to be let. The lease may also contain EPC-related clauses, for instance prohibiting the tenant from carrying out any alterations that may adversely affect the rating, or restrictions about when a tenant may commission a new or replacement certificate.

Full repairing: leases come with a variety of repairing requirements, one of which is full repairing. This means that a tenant is responsible for repairing the whole premises, usually including the walls and roof. It contrasts with leases that cover just the internal parts of a property, which are known as internal repairing only leases. Another common term is full repairing and insuring (FRI), which also obliges a tenant to insure the premises. Understanding the extent of a tenant's repairing liability is key to keep a property at the required standard, as is the wording of the clause. For example, to 'put and keep' may require a tenant to bring a property into a better state of repair than that in which it was originally let.

Guarantees: where a landlord considers that a tenant's covenant is insufficient for the amount of rent payable, a guarantee may be required. The guarantor will usually be a party to the lease – often a director of the business, making that guarantee in a personal capacity – and will underwrite the tenant's covenant in the event of non-compliance, such as failure to pay rent or service charges.

Heads of terms: before entering into a lease, the landlord and tenant should agree a set of heads of terms. These should align with the mandatory requirements of the RICS Code for leasing business premises

Insurance: a lease will define who is responsible for insuring the premises, because a property cannot be insured twice. Typically, the landlord will retain responsibility for insuring the premises and charge the tenant accordingly.

Jointly and severally liable: if more than one party is the tenant to a lease, they are likely to be jointly and severally liable. This means that the responsibilities and liabilities under the lease are shared by all tenants and, in the event of default, one or all parties could be pursued for the joint overall liability. 

Knowledge: familiarity with actual leases and terms is key for all surveyors, because most property instructions are based on the lease in place. For instance, the frequency of a rent review depends on the relevant clause, property management will depend on a variety of clauses, and a capital valuation will be influenced by the terms of the lease, i.e. the income profile will affect the capital value once capitalised using an appropriate yield. If you do not understand the implications of lease clauses, which can often be complex, you will be unable to advise your clients diligently and competently.

Length of lease: otherwise known as the lease term, this is the duration that the lease will run for. The lease should define its exact start and end dates, although sometimes the termination date is based on a formula: for example, ten years from X or expiring on the tenth anniversary of Y. Understanding how to identify exact dates is vital because such formulae can often make clarifying them difficult.

Movement in rent: many leases will include a rent review clause that allows for movement in the rent during the lease term. Rent reviews come in a variety of forms, including upwards only, upwards or downwards, fixed increase, and can be linked to an index such as the Retail Price Index or Consumer Price Index. Some surveyors will specialise in dealing with rent reviews and be experts in analysing and advising on the assumptions, disregards, hypothetical lease terms and timing in such clauses. Generally, any agreement on a rent review should be documented in formal written memoranda appended to the lease for future reference.

'If you do not understand the implications of lease clauses, you will be unable to advise your clients diligently and competently'

Notice: there are many forms of notice that might need to be served under a commercial lease, such as a break notice, a notice to quit by a tenant under section 27 of the Landlord and Tenant Act 1954, or a rent review notice. In these cases, leases also often refer to section 196 of the Law of Property Act 1925 relating to service of notice by a landlord. A notice is deemed received by the tenant if it is served in one of a number of ways, including leaving it at their last known address, affixing it to a location where they will have to remove it to gain entry, or by using registered or recorded post. 

Operational performance: it is imperative to ensure that the parties understand how management and operational performance responsibilities are split under the lease, including building management, cleaning, security, utilities and waste management. The lease should clearly define these, which may cover costs such as utilities not dealt with under any service charge.

Part II of the 1954 Act: this relates to the tenant's security of tenure and renewal rights. Where the act applies to business premises, the tenant will have the right to renew at expiry. My previous article on the act offers more detail.

Quiet enjoyment: most leases include the tenant's right to quiet enjoyment of the premises; this means that they can occupy without disturbance or interference from the landlord. The right arises from Jenkins v Jackson [1888] 40 Ch D 71,74.

Reading a lease: leases are often complex and unclear, requiring surveyors to be diligent in interpreting their wording and implications; in some circumstances, this may entail reference to a solicitor. The starting point, however, is always the actual wording of the lease and the intentions of the parties. This will require interpretation of the words used in specific clauses, the wider context of the lease, and the factual background to the agreement between the parties. Sometimes it will be necessary to imply a term not written into the lease, and in the worst case – for instance, when a mistake has been made in the drafting or the lease does not reflect what was supposed to have been agreed – the courts can be asked to intervene and amend the wording.

Service charge: where a property is occupied by multiple tenants, a service charge may be provided for in the lease. The applicable costs will typically cover the repair of any common structures such as roofs, as well as common services such as the cleaning of common areas. The lease will define what services are included and how the charge is apportioned, for example weighted according to the floor area each tenant occupies. Landlords and their agents should adhere to the RICS Service charges in commercial property when operating a service charge. 

Title: where a tenant's lease is for a term of seven years or more then it must be registered at the Land Registry under the Land Registration Act 2002. All leases should be agreed in writing for clarity, and the liabilities between the parties defined. 

'Leases are often complex and unclear, requiring surveyors to be diligent in interpreting their wording and implications'

User: this will define:

  • how a tenant may use a property, e.g. the business or trade they carry out, such as a shop, a pub or a hairdresser, including any prohibitions, such as the residential use of commercial premises 
  • the permitted-use class, for example class E for commercial, business and service uses
  • how a tenant can apply for change of use, if permitted. 

Having some control over the use of a property helps landlords retain value and apply the principles of good estate management, such as avoiding competing uses or uses that disturb other occupiers.

Variation: lease terms can be altered or varied by agreement between the parties. These variations can be agreed in several ways, including deeds of variation, licences or side letters, which may be personal to the named tenant. If the lease term is varied, this could be documented by way of a reversionary lease, a surrender and regrant, or a deed of variation. In each case, the implications for stamp duty land tax need to be considered.

Waiver: some leases will include an agreement to waive the tenant's right to compensation for disturbance under section 37 of the 1954 Act. This may allow a reduced rent to be negotiated or avoids the complexity of the Act and service of notices. However, generally this will be a requirement of the landlord and favourable to them, rather than the tenant. Contracting out can facilitate redevelopment or future strategies for the property. Again, my previous article gives more detail about what section 37 covers and when compensation for disturbance may be payable.

X-ray: surveyors may feel they need X-ray vision when reading and summarising leases, because a high level of analysis and accuracy is required. Among the questions to consider are the following.

  • Have you checked the page numbers to ensure all pages of the lease are included and none is missing from the copy you've been given?
  • If you are looking at a print or electronic copy, have you read the clause in question word for word and how clear is it?
  • Have you considered the relationship between different lease clauses, such as break option and term dates, when advising your client?

Years or months: typically, parties will agree to pay rent monthly; this tends to be more common now to help tenants manage cash flow effectively. However, they could opt for more traditional quarterly provision, in which case knowing the correct quarter days is essential. In England and Wales these are 25 March, 24 June, 29 September and 25 December; in Scotland, 28 February, 28 May, 28 August and 28 November; while for local authorities they are 1 January, 1 April, 1 July and 1 October. However, yearly or other payment frequencies are also options.

Zero carbon: the pursuit of net-zero carbon by the UK government and many businesses means that green lease clauses are becoming more and more popular. These can be used to limit the environmental impact of a lease through clauses such as sharing energy usage information, so the parties can meet any reporting obligations and have an awareness of energy usage, ensuring that alterations are carried out in a sustainable manner and requiring compliance with MEES.

 

Jen Lemen FRICS is co-founder of Property Elite
Contact Jen: Email

Related competencies include: Landlord and tenant, Leasing and letting, Property management, Purchase and sale

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