Following on from our review of general considerations for landlords in preparing heads of terms (HoTs) for Scottish commercial leases, there are a few monetary aspects which a landlord could consider clarifying at HoTs stage to avoid revisiting the HoTs. Parties not being aligned on the underlying intention is generally most common with cost elements. Providing further detail for those in HoTs helps avoid that.
Rent
The rent may be an agreed £ per square foot of the premises. It is helpful for the HoTs to confirm both (i) the square foot area and (ii) the initial annual rent the calculation produces. That avoids any miscalculation or disagreement on the actual rent payable, particularly if it’s the exact figure or whether it's rounded up or down to the nearest £5 or £10.
Additional Rent
Where the letting includes additional rent, such as car parking or storage, it’s important to specify whether the rent for that is included in the main rent or charged separately. Also confirming whether that rent is subject to rent review on the same intervals and terms as the main rent is prudent.
Rent Reviews
Whilst five yearly rent reviews are considered market standard for longer leases, it is still helpful to record the intervals and mechanism in the HoTs.
Open Market Rent
With an open market rent review, it is useful to set out the hypothetical lease term: the original lease term, the remainder of the lease term, or another period? Similarly, confirming the review is upwards only (higher of passing and open market) removes any dubiety, even if downwards rent reviews are currently rare. Whilst the open market rent assumptions and disregards are usually left for the lease, if a party has a specific assumption or disregard then including that in the HoTs is helpful.
Index Linked
Some leases will have index-linked rent reviews by reference to RPI or CPI. It’s helpful for the HoTs to confirm which index and, if RPI, whether it includes mortgage prices (i.e. RPI or RPIx).
To avoid extreme rent fluctuations, index linked reviews may be subject to a cap and collar (maximum and minimum increases) to provide both parties with a degree of certainty as to the reviewed rent. As that impacts the rent increase, it’s best to set that out in the HoTs.
An important consideration is whether the increase should be compounded annually over the review period, or calculated between lease start or prior review and current review. The reviewed rent is likely to be different under each calculation, depending on the index fluctuations. So, with an index-linked increase, ideally the HoTs state the agreed mechanism.
Stepped Rent
A more straightforward mechanism is fixed rent increases. These stipulate pre-agreed rent increases at set intervals over the lease term, offering predictability for both parties but without adjusting to actual market conditions or inflation. Depending on the lease term, there may then be a rent review on expiry of the stepped increases (e.g. 10 year lease: first 5 years of fixed increases, then rent review). Recording that rent review too in the HoTs puts it beyond doubt.
Service Charge
Whilst service charge provisions are standard, unclear wording in HoTs may lead to disputes over which costs are chargeable. Key considerations for landlords include:
Basis of calculation – whilst the HoTs may refer to the landlord’s standard lease, it may be prudent reiterating the tenant’s proportion in the HoTs (e.g. fair and reasonable, based on NIA or GIA, a specific %). Where that is different to the standard lease, it’s worth clarifying if that arrangement is personal to the tenant.
Exclusions – HoTs do not typically detail all service charge inclusions or exclusions, but landlords should consider whether anything specific should be referenced. For example, energy efficiency improvement costs for the building are becoming increasingly relevant, as sustainability initiatives gain momentum; and utility costs are often excluded from the service charge and paid separately.
Caps – increasingly, tenants are seeking caps limiting their service charge liability. If agreed, HoTs could address:
- Duration — whether the cap applies throughout the lease or just an initial term.
- Cap review – to ensure service charge caps remain commercially viable, periodic cap reviews are common e.g. increasing annually in line with RPI or CPI to reflect cost fluctuations.
- Date of cap review – in an ideal world, each lease would start on the service charge year start date. In practice that’s unlikely. It’s therefore helpful to state when cap increases occur. From the tenant point of view, they want the benefit of the full cap so usually look for the cap to increase on each anniversary of lease start.
From the landlord point of view that can be problematic as the cap could increase during a service charge year. Where there is more than one tenant on a cap, with different lease start dates, there may be multiple caps changing at different times during a service charge year. As well as the admin complications, that could impact on service charge recovery and, consequently, the shortfall which would fall to the landlord.
A cap increasing at the start of the service charge year is simplest, but that needs to be considered in light of the lease start date: does that result in a significantly shorter or longer period for the initial cap before the increase applies?
Insurance
While HoTs do not usually include detailed insurance provisions, they would confirm whether the lease is FRI (full repairing and insuring - the landlord insures and the tenant meets the costs). The proportion of insurance costs is generally fair and reasonable covering insured risks, public liability, and loss of rent/service charge. It should also include periodic insurance valuations, as well as excess payments.
One consideration, particularly for retail premises, is who insures the plate glass. That depends on the premises - with a shopping centre unit, it’s likely to fall within the landlord’s insurance; with a single high street retail unit, it may fall to the tenant.
Key takeaways
Whilst it is not the intention to turn HoTs into lengthy quasi-lease documents, providing some extra detail on monetary aspects ensures both parties understand the practical implications of key cost mechanisms at the outset of negotiations.
Contributors
Associate
Solicitor
