Heads of terms checklist for commercial landlords

Good advice when negotiating heads of terms (HoTs) on a commercial lease can make your property more attractive and get you better business outcomes. Our checklist highlights the key points to consider.

Tenant’s details and covenant strength

Identify the tenant: As soon as possible, be clear about the identity of the actual tenant. With any commercial lease, the tenant covenant (essentially their creditworthiness) is crucial to ensure compliance with the lease throughout the term and protect investment value.
Covenant: If the tenant is a company and its accounts suggest its covenant may be weak (or if the company has only just been incorporated), consider obtaining a personal guarantee from a director and / or a rent deposit. If you do so, make explicit provision for this in your HoTs.
Guarantees: If you’re asking for a guarantee, the identity of the guarantor should be clear in the HoTs, along with the length of time the guarantee will apply.
Rent deposits: With rent deposits, the HoTs should be clear on the amount (including VAT, if applicable) and the length of time the deposit will be held. They should also include provisions for increasing the deposit over time and the terms for returning it to the tenant in future.

Inducements

Inducements: As a landlord, you should carefully consider any inducements you might offer, thinking about the demand for the type of property being let, the comparable inducements agreed elsewhere, and the ongoing liability of having an unlet property (from a rates, maintenance and insurance point of view).
Capital contributions: An alternative inducement to a rent-free period, or as an additional inducement where a fit-out would be expensive, is to offer the tenant a capital contribution.

Rent

Reviews: Rent review provisions are fundamental to a commercial lease (dependent on the duration). Reviews normally occur every three to five years and, at present, should be upwards only. Legislation may soon be introduced in England banning upwards-only reviews, but there is no immediate sign that Scotland will follow suit.
Basis of review: This is an important consideration for landlords, and the HoTs should be clear on whether it will be reviewed against open market value or increased in line with the Retail Prices Index (RPI) / Consumer Prices Index (CPI). Your advisers can explain the pros and cons of each.
Open market: When calculating a new open market rent, surveyors will look, wherever possible, to comparables in the local market. If the market is buoyant, that will reflect positively on the new rent calculated. Where the market is struggling, comparables will be weak, as will any uplift.
RPI / CPI: Where rent is reviewed and increased in accordance with any increase in RPI / CPI, landlords should take advice on: (1) which index to use; (2) whether there should be a notional annual review (recommended); and (3) whether there should be a cap and collar (e.g. a minimum increase of 1% and a maximum increase of 3% on each notional annual review).

Obligations and rights

Repairing obligation: It is imperative in a commercial lease that the landlord shifts essentially all and any liability for the property to the tenant. The ideal / institutionally acceptable commercial lease is a full repairing and insuring (FRI) one. However, an FRI lease can be qualified where the parties agree, with any qualification made clear in the HoTs.
Alterations: Your HoTs should be clear on the tenant’s rights (and obligations) as far as alterations are concerned (they can usually make internal non-structural alterations without consent, with consent required for anything else). You should also discuss the tenant’s obligations at lease expiry too (the default being that the tenant must remove any alterations and reinstate).

Assignment and subletting

Alienation: The terms under which the tenant may assign or sublet their interest should be made clear in the HoTs.
Assignation: The test for assignation is usually with landlord’s consent and only where the assignee is responsible, respectable, and of sound financial standing. This will help protect you from an assignation to a tenant of lesser covenant strength. Assignation of part of the lease property should be prohibited.
Subletting: The original tenant remains on the hook when subletting so the test is lower, requiring any subtenant to be responsible and respectable only.
Subletting in part: Most landlords prefer to restrict subletting in part, in order to avoid a proliferation of different tenants in their premises. Where the tenant leases a number of floors, landlords sometimes allow subletting of, say, an entire floor but this is relatively rare.

Service charge

What it covers: Where the property forms part of a larger building or estate, you should make sure there are no gaps between what the tenant is directly responsible for (the property) and what you agree to maintain (the common parts).
Right of recovery: As a landlord, you should ensure your right of recovery under the service charge is wide and that any exclusions are as limited as possible.

How we can help

Both landlords and tenants can benefit from independent legal advice on all these issues and others. Our experienced commercial property team will look for practical solutions that suit your business size and ambitions, and we can also connect you with surveyors, agents and other advisers who know the local market well. Together, we’ll help you achieve your business goals.