Commercial property leases vary considerably, from large-scale shopping complexes to offices. The types of rent paid, how they are calculated and when they are paid, also vary. Both landlords and tenants will need to consider carefully the commitments that they make relating to rental payments (including any provision for change over long periods) when entering into a commercial property lease. Beyond striking a commercial deal on the initial rent rate, it is important for both parties to be clear on what a lease provides for in respect of rent and related matters.
In this article, our commercial property solicitors discuss the different types of commercial property rent, ways you can respond to rent increases and how you can negotiate rent payments with your landlord.
In this article, we cover:
Types of rent payable
Rent is a basic feature of any commercial property lease. Most commercial leases include provisions which provide for the payment of rent by the tenant over time. Base rent is commonly set at a market rate and subject to rent reviews to ensure that the landlord continues to receive payments in line with the prevailing market conditions throughout the term of the lease.
The following types of rent are common within commercial leases:
Base rent
This is the basic rent payable, commonly reflecting the market value and paid in consideration for the landlord making the property available to the tenant.
Insurance rent
Insurance rent is any additional rental payment due to cover the cost of insurance (commonly payable by the tenant, if the building is multi-tenanted then the tenant will pay the relevant percentage).
Service charge rent
Service rent is an additional rental payment designed to cover the cost of services to the premises.
The insurance rent and service charge rent are not rents in the sense that the landlord is making money from them, but they are there to reimburse the landlord for the costs they have incurred. They are often referred to as ‘rents’ in a lease though as it then makes it easier for the landlord to recover them (for reasons that fall outside the scope of this article).
There are various other terms used, relating to the subject of rent and these include:
Ground rent
This term is ordinarily used with reference to a nominal rent. It is common where a rent premium is payable upfront and often any ongoing rent is nominal and not by reference to the market conditions. This is commonly known as ‘peppercorn’ rent, which is essentially nothing. It is now becoming increasingly common that leases are drafted on the basis that the landlord will charge £1 per annum instead of a peppercorn, but this £1 is never collected in practice.
Market rent
Market rent is a rent which reflects the prevailing market conditions. It is the rent that could be obtained if the property was available on the open market. Market rent is sometimes referred to as ‘OMRV’ (Open Market Rental Value).
Whilst a lease is ongoing, it will also be common to hear open market rent defined as the rent that it would be adjusted to if the property was available to let in the open market at the relevant date. The lease will normally include a number of assumptions and matters to be disregarded (for example, use type, state of repair). What is assumed and disregarded can significantly impact on a final determination of the open market rent.
Peppercorn rent
This is similar to ground rent. It is a nominal rent that is commonly paid in long leases. Often a peppercorn rent will be £1 per annum but can be defined as ‘one peppercorn’.
Rack rent
A rack rent normally means the same as market rent. It is the best rent that can be obtained on the open market.
Indexed rent/RPI rent
Indexed rent refers to the fact that any changes in rent are linked to an inflationary index. An example of this may be the Retail Price Index (RPI). Index-linked rental increases are common, although they can result over time in the rent becoming out of step with true market rent (where the index does not track the relevant property market). A landlord may wish to ensure that rent is upwards only, further they may look to have increases at the greater of an index and the market. A prudent tenant would look to limit how much the rent can increase by upon such a review.
Turnover rent
Turnover rents are more common in the retail sector. This defines a type of rent that is pegged to the turnover of the tenant at the premises i.e. the higher the turnover, the higher the turnover rent. Turnover rent is usually paid in addition to base rent, but allows the landlord to share in some of the risk and reward of the tenant’s business. Landlords can often be wary of this approach though as it will be heavily reliant upon the tenant running the business successfully in order to receive higher rents.
A variation of this is a percentage lease. This is where the tenant will pay a base rent, but in addition will pay a rent based on a percentage of a particular indicator (such as profit or footfall).
FRI leases
FRI is an abbreviation for ‘full repairing and insuring’ obligations of the tenant. If the tenant takes on a lease of a whole building, they will be fully responsible for repairing the building and covering the cost of the buildings insurance policy. If their lease is of part of the building, they will be required to contribute a fair proportion of the cost of repairing and insuring the whole building. Most commercial leases are prepared on this basis. The obligations taken on by a tenant to repair the property may have a bearing on rental payments.
When is rent paid?
Rent is usually paid as follows:
- As a rent premium, upfront: this is common for long leases
- On a periodic basis: this is commonly on a monthly or quarterly basis on the quarter days
What is load factor?
Load factor is the term used to define the method of calculating the total monthly rent based on area (in particular taking into account shared use of a common area.)
Gross leases
A gross lease is a form of lease where the tenant pays a fixed rent which includes the cost of all other ownership related expenses (such as utilities, taxes, all of which are borne by the landlord). The term ‘gross’ signifies that the rent payable is the total gross sum due from the tenant.
Net leases
A net lease is distinguished from a gross lease, in that it requires the tenant to pay some or all of the expense of the property, in addition to the normal rent.
Reference to ‘Single net leases’, ‘Double net leases’ and ‘Triple net leases’ signify the number of expense types met by the tenant (of taxes, insurance and maintenance and repair).
Long term leases and rent reviews
Long term leases (where value for the property is recovered by the landlord through regular rental payments, not upfront premium), often include rent review mechanisms and opportunities for the lease to be terminated (break dates).
The mechanism for rent review is ordinarily set out within the lease. It will describe the frequency of the reviews and how the rent will be determined. It is typical for rent to be reviewed every three to five years. Short term leases are unlikely to include rent reviews.
Rent is commonly determined by reference to an index or the open market. The open market rent is impacted by the local area and general level of rents. The market may also vary depending on the type of use of the property.
A lease may specify whether improvements made to the property are taken into account for the purpose of rent review or whether they will be disregarded.
The landlord will be permitted to inform a tenant of a new rent following a rent review. The tenant will commonly have a right under the lease to object to any revised rent. After that, a dispute may be referred to an independent expert (such as a surveyor, appointed by the parties, or in default of agreement by a reputable body) for determination.
The interaction between rent payments, rent review and break dates is important. Careful consideration should be given to rent payment dates and rent review dates. A tenant should ensure that any rent payment dates fall after a rent review or break dates. This is to avoid:
- Rent being paid in advance (which could be a considerable sum if rent is paid annually or quarterly), shortly before a lease is due to expire. The tenant may then suffer a cash flow impact and/or credit risk on the advance.
- Any rent review taking effect retrospectively to the previous rent payment date (which may be a lengthy period if rent is paid annually or quarterly).
What considerations impact the negotiation of commercial rent terms?
Market conditions: The current market conditions, including supply and demand, vacancy rates, and rental trends, can significantly impact rent negotiations. In a competitive market with high demand and low vacancy rates, landlords may be at an advantage to justify higher commercial rent terms. In a market with high vacancy rates or economic downturns, tenants may have more negotiating power to secure favourable rent terms.
Location and quality: The location and quality of the commercial property can also influence rent negotiations. Prime locations or properties with desirable features, such as high foot traffic, ample parking, or modern amenities, may command higher rents. Landlords of properties in less desirable locations or with lower-quality features may be prepared to be more flexible in rent negotiations.
Tenant standing: Landlords often consider the financial health and stability of potential tenants when negotiating rent terms. Strong financials, a solid credit history, and a proven track record of success can enhance a tenant's bargaining position and potentially lead to securing more favourable rent terms.
Lease term: Some Landlords may be more willing to offer lower rents for long-term leases, as it provides stability and reduces turnover. They may not be as flexible with shorter lease terms in order to compensate for interruptions in rental income or potential vacancy periods.
Tenant works: Tenants who need to make specific customisations or renovations to the commercial space to suit their needs may wish to negotiate rent concessions or rent-free periods to allow time to set up shop before trading. Landlords can also offer such concessions as an incentive to tenants.
Tenant mix and compatibility: In multi-tenant commercial properties, landlords may consider the tenant mix and compatibility when negotiating rent terms. A diverse mix of complementary businesses can enhance the overall appeal of the property and therefore Landlords may offer more attractive rent terms to tenants that align with the desired tenant mix.
Operating expenses and additional costs: It is important to consider the allocation of operating expenses and additional costs, such as property taxes, insurance, maintenance, and utilities. Negotiations should clarify which party is responsible for these expenses, how they will be calculated and passed on to the tenant. The allocation of costs and expenses can inform and dictate commercial rent terms - for eg whether it Is a gross lease, net lease, FRI lease (as detailed above).
Rent escalation: The potential for rent escalation or rent increases Is a key consideration during negotiations. Landlords often seek upward only rent reviews based on market rent or tied to inflation (this is common practice). Tenants will be cautious to limit the extent of these provisions so that rent increases do not become unmanageable.
Negotiation strategies
When it comes to negotiating commercial rents specifically, some strategies to employ include:
Market-backed research: Entering the process with a thorough understanding of comparable rents and market rates in the area provides a benchmark for negotiations and can help you justify desired rent terms.
Coming from a position of strength: To elevate your bargaining power, consider highlighting your key strengths. For tenants, this might include a strong financial position, a successful track record, or the potential for long-term tenancy.
Consider other costs: In addition to rent, other payments may be due under the lease such as service charges and insurance premiums (which are often themselves reserved as ‘rent’). Exploring these additional costs in negotiations may provide opportunities for compromise and potentially offset higher rent costs.
Seek rent concessions: Tenants may seek to negotiate rent concessions at the early stages of the lease to provide financial relief while they set up and establish themselves in the new premises. Concessions could take the form of a rent reduction for an initial period, a rent-free period, or a step-up rent structure. Landlords may also wish to offer rent concessions as incentives to attract tenants. The prevailing market conditions influence the availability of such terms.
Longterm potential: If the tenant intends to establish a long-term relationship with the landlord, they can emphasise this commitment during negotiations. Landlords often prefer stable, long-term tenants and may be more willing to negotiate favourable rent terms to secure a reliable tenant.
Don’t put all your eggs in one basket: Having alternative options or backup properties can provide leverage during negotiations and give tenants the confidence to pursue other opportunities if needed.
Rent Increases
Do I have to agree a commercial rent increase?
It is common for parties to negotiate and agree upon the frequency, timing and method of rent reviews in the commercial lease. When the time comes, whether your agreement Is required for the rent Increase will very much depend on the terms of the lease. If rent Increases are due on set dates by reference to a fixed percentage, this has essentially been agreed in advance. Other leases, may specify notice periods and procedures for initiating rent reviews, as well as dispute resolution mechanisms in the event of a disagreement regarding the revised rent. Landlords typically insist on upward only rent review provisions and an increase Is inevitable, but the amount by which must be in agreement.
How much can a landlord increase commercial rent by?
The amount by which the rent can increase on rent review very much depends on the terms of your lease and market conditions. Upward only market rent review provisions are commonly used in commercial leases, meaning the rent can only go up or stay the same - it cannot decrease, regardless of market conditions.
In some cases, the lease may specify a fixed percentage increase, such as 3% per annum, while others may link rent increases to changes in a specific index, such as the Retail Price Index (RPI). The lease may specify that rent will be increased by whichever is higher of the mechanisms contained within the rent review provisions.
In leases where such mechanisms are not specified and the rent is reviewed to keep It in line with current market rates, the process typically Involves engaging-local property experts, studying comparable rents in the area and agreeing on the figure. It is common for parties to negotiate and agree on a ‘hypothetical lease’ In the rent review provisions. The hypothetical lease establishes what the rent would be if the property were to be leased under current market conditions at the time of the rent review, with various assumptions and disregards made with a view to achieving a fairer assessment.
How much notice does a Landlord have to give before they increase the rent?
The lease agreement usually outlines the specific notice period required for rent increases. Longer term leases sometimes include a mechanism predetermining rent increases at fixed dates. Others may simply state that reviews will take place at certain intervals, such as year three and five of the lease. In these scenarios the Landlord typically sends a trigger notice to the tenant that they plan to initiate the rent review. This can be anywhere between one month to 6 months (sometimes more), but it is common for leases to fall around the 3-month mark for notice.
If the lease does not specify a notice period for rent increases, the landlord must provide "reasonable notice," which is usually considered to be at least one month.
What If I can no longer afford the rent payments?
If you are not keeping up with rent payments, there are a number of legal options available to both you and your landlord. Most commercial leases contain a forfeiture clause giving the landlord a right to recover possession of their property through re-entry. They may also choose to obtain a judgement at court for the outstanding monies, or even seize your goods. If you are unable to pay your commercial rent, it is best to be proactive and consider:
- Negotiating with your Landlord: The first step is to simply communicate your situation to your landlord. They may be willing to negotiate a temporary reduction in rent, a payment plan, or put other arrangements in place that could help you through periods of financial difficulty. This is not a long term solution.
- Exploring financial assistance: Depending on your circumstances, you may be able to look into government support programs, grants, or loans that may be available to help small businesses facing financial hardship.
- Reviewing your lease agreement: Check your lease agreement to understand your rights and options regarding early termination.
- Subleasing or assigning the lease: If allowed under your lease agreement, you could explore subleasing the space to another tenant or assigning the lease to someone else.
What happens If you are late in paying your commercial rent?
Cash flow may not always be steady in business, and if you envisage that you will be late in paying this quarter or month’s commercial rent - it is wise to communicate with your landlord regarding a deferment. Technically speaking, If the rent is paid late, the lease agreement may provide that interest is charged or a late payment fee applied. As to whether the landlord chooses to waive such a right Is a matter for each Individual.
In persistent cases of late payment of rent, the landlord may take legal action or terminate the lease.
Summary
Commercial rents are the key driver for landlords looking to generate an income from their property. For that reason, commercial landlords will want to maximise their rental yield and profit. For tenants on the other hand, this is an operating expense that eats into their turnover. It is essential at the outset to agree on a commercial rent structure and figure, including rent review provisions, that is financially workable for both parties. Current market conditions, property location, the financial strength of the tenant and other factors can Influence a party’s bargaining power, resulting in more favourable or less favourable terms depending on the circumstances.
It is important to approach commercial rent negotiations with a clear understanding of these considerations and to engage in open and transparent communication with the landlord or their representatives. A well-prepared negotiation strategy can help secure favourable rent terms that align with your business goals and financial capabilities.
If you are about to sign up to a new lease or are approaching rent reviews in your existing lease, our friendly, expert commercial property solicitors are here to navigate you through the complexities and make It work for you.
