This guide sets out what principal terms will generally be in the Heads of Terms, why they are significant for you the tenant and what you need to think about before agreeing them.
The first step in taking a lease of new premises is to agree Heads of Terms with the landlord.
Heads of Terms set out the main terms of the letting and will be incorporated into the formal legal lease. Heads of Terms are not legally binding but they are difficult to change at a later stage.
1) Premises and Rent
Most fundamental is the rent. This is generally a fixed amount per annum payable monthly or quarterly in advance. If the lease is for more than 5 years you may have a rent review clause which will increase the rent to the market rent at the “review date”. Instead of having an open market rent review you can have a fixed increase or an increase linked to inflation both of which will give you more certainty.
Sometimes the rent is linked to the area of the premises which means the premises need to be measured before completion. The final measured area can be higher than the estimated area in the Heads of Terms and this could mean a substantial increase in the rent.
It is also worth noting whether the building is elected for VAT. If the building is elected for VAT, the tenant will be liable to pay VAT on the rent and most other outgoings due under the lease. If you are unable to recover VAT this is important.
Most leases have a rent free period at the start of the lease and the length of the rent free period is a matter of negotiation. Unless you have expert advice, you may be paying above market rent for the premises.
2) Length of the Lease
The length of the lease needs to be appropriate to your business needs. Increasingly tenants are wary of signing up to long leases with no exit route.
If the landlord insists on a lease term longer than you want, ask for a break clause.
If the Heads of Terms have a tenant break you should check what the conditions of the break clause are. The only conditions you should agree to are that the main rent (not other rents) is paid up to date and that vacant possession is given at the break date.
3) Service Charge
You will generally have to contribute a “fair” proportion of the landlord’s costs of maintaining the structure and common parts of the building and providing other standard services.
The previous years’ service charge accounts can provide a guide as to what the service charge cost might be. However if major works are needed this figure can increase dramatically.
Consider asking for a service charge “cap” (an upper limit on the service charge) which will increase annually in line with inflation or even fixed service charge as a way of limiting your risk.
Your needs may change in the future and it is important to make certain that you have the right to either assign or underlet the premises.
The general position is you need the landlord’s permission to assign the lease or underlet but the landlord must give that permission IF REASONABLE.
Some companies will want to share their premises with other group or associated companies. If you intend to share the premises, make sure the Heads of Terms allow this. Sometimes you might want to share occupation with companies you work closely with but who are not group companies. If so you need to agree this with the landlord.
5) Repair and Decoration
The tenant generally has to keep the premises in good repair and condition. If the premises is in a poor condition at the start of the lease, this will mean that at the end of the lease the tenant would have to “improve” the premises into a good state of repair which could be very expensive.
So if the premises are old and worn make sure you limit your repairing and decorating liability so you do not have to put the premises into any better state of repair and decoration than as at the start of the lease.
The tenant will usually require landlord’s consent to carry out any alterations to the non-structural parts of the premises.
Often the only alterations you will carry out are installing internal partitioning so include a provision in the heads of terms which allows you to install partitioning without the landlord’s consent.
This will reduce the extra costs and time associated with obtaining a licence for alterations from the landlord.
7) Rent Deposit and Guarantor
The landlord may request a rent deposit depending on your financial strength. The amount of the rent deposit is a matter of negotiation but generally landlords expect a deposit equal to 6 months rent plus VAT.
An alternative to a rent deposit is for you to provide a guarantee and this should be dealt with in the Heads of Terms.
You will need to pay the landlord’s costs for insuring the building and for 3 years loss of rent.
Generally you will not have to pay rent if the building is damaged or destroyed by an insured risk for a period of 3 years.
Tenants are increasingly succeeding in not having to pay rent if there is damage by an uninsured risk. The standard position is the rent will be suspended from the date one year after the date of the damage.
- USE AN EXPERIENCED COMMERCIAL AGENT TO HELP YOU. Unless you are certain you have negotiated the best terms, consider using a good commercial agent. They will know what the market rent is and often will know what other terms can be negotiated to your advantage. If you negotiate directly with the landlord you may lose out on major concessions better advised tenants are winning.
- USE A LAWYER TO CHECK YOUR HEADS OF TERMS. You will have to use a lawyer to negotiate the lease anyway so before you sign off on the Heads of Terms make sure your lawyer has reviewed them to ensure there are no legal issues. Here at EC3 Legal LLP, we are delighted to review any Heads of Terms agreed for no charge.