A Guide to the Property Market of England & Wales
Part III - The Legal Principles in the Acquisition of Office Property
Freehold
The purchaser will usually pay a capital sum to the vendor (normally the existing freeholder) in return for the freehold title in the property. The property can either be vacant, part occupied or fully let. The latter is regarded as a true investment property as there is no beneficial occupation available to the purchaser but only the immediate benefit of an income stream.
Leasehold
When a tenant takes a lease from a landlord, he will pay a rent to the latter for the benefit of that lease and, generally, for the right of occupation.
Essentially a leasehold interest can be acquired on two bases:-
A New Lease
A tenant will take a new lease from a landlord for a specified number of years. The landlord can either be the freeholder or a tenant holding a leasehold interest, who has the right to immediate beneficial occupation of the premises to be leased. In this case the lease granted is known as a sub or underlease. In return the tenant will pay a rent to the landlord throughout the term of the lease.
When taking a long leasehold interest the tenant will frequently pay a capital sum to the freeholder either with the right to receive a proportion or all of the income from the existing occupational tenants, in the instance of an investment, or for the right to occupy all or part of the premises themselves. Either way the tenant will pay to the landlord either a peppercorn (i.e. nominal) or geared rent (i.e. a proportion of the market rent).
An Assignment
Generally, under the terms of an occupational lease a tenant has the right to assign, and often sublet, his leasehold interest for a period of years up to the expiration of the term. The assignor, or existing tenant, can therefore assign his lease to an assignee or new tenant, having first satisfied the various provisions within the lease with regard to the alienation provisions which includes obtaining landlord's consent. The assignee will take on the existing lease and covenant directly with the landlord to adhere to its terms and conditions, without alteration and pay rent directly to him.
As rentals are generally reviewed 5 yearly, the passing rent contained within the lease can be below the open market rent and in such instances an assignee may pay to the assignor a capital sum. This sum may reflect not only the capitalised value of the differential between the passing rent and the open market rent up until the next rent review, (known as the profit rent) but also the value of the existing tenant's fixtures and fittings, if any. During times of an oversupplied market this payment can be reversed and the assignor will pay to the assignee a capital sum as a financial inducement for the latter to take the lease (reverse premium).
A New Lease or an Assignment
There are both advantages and disadvantages in taking assignments of existing leases as opposed to taking new leases. These will be a reflection of the prevailing market conditions at the time when the lease contract was originally negotiated in comparison to the conditions of the market at the time of the potential assignment.
Market Conditions
In times when demand exceeds supply it is likely that a lease will be drafted with the tenant’s obligations and rights more in favour of the landlord. If the office market falls thereafter the passing rent contained within the lease may be higher than that which could be negotiated at the date of the proposed assignment. This differential is often reflected by the existing tenant either paying a capital sum to the assignee or providing a rent free period to reflect this higher level of rent or a blend of the two. Conversely, when supply exceeds demand a tenant is able to negotiate more favourable lease provisions which, amongst other things, could include break clauses and a less onerous rent review clause. In a rising market the passing rent could often be lower than the open market rent at the time of the proposed assignment and therefore there could be a cost saving. In such instances it is common that the existing tenant will seek a capital sum or premium to reflect this rent differential. See above.
Dilapidations may well become an issue at the expiry or determination of the term, involving the tenant in potential costs associated with the damage incurred during occupation – removal of fixtures and fittings may be only part of the claim (see Glossary of Terms, pages 24 and 29) and page 9 para. e).
Fixtures and Fittings
Office premises held under a lease which the tenant is seeking to assign have nearly always been fitted out by him e.g. partitions, kitchens etc. which cannot be removed without causing damage. This can also be the case in the instance of an underletting. Again, depending on prevailing market conditions, the tenant may seek a capital sum from the assignee to reflect the value of these items. Such fixtures and fitting are normally very personal to a tenant's occupancy of the accommodation and can be of little or no value to another tenant or indeed of negative value should they be expensive to remove. Of course, there are some instances where all or a majority of these fixtures and fittings can be utilised by the assignee and thus could save considerable time and expense in fit-out works.
Legislation
New legislation is continually being introduced which affects leasehold transactions. For example, the introduction of VAT on rents (unless otherwise agreed, the landlord has sole discretion on whether to charge VAT or rent) could potentially affect all leases drawn subsequent to the passing of the Finance Act 1989 which brought about these changes, as the drafting of leases prior to that date would not have separately covered that eventuality. Again, a tenant's or landlord's negotiating position very much depends on the prevailing market conditions and in this instance should a market be experiencing an oversupply, then a tenant negotiating on a new lease may be able to mitigate or totally remove the effects of VAT, subject to the impositions of statute, on rent so far as that particular lease is concerned.
Part I - Property Tenure
Part II - Property Leases
Part III - The Legal Principles in the Acquisition of Office Property
Part IV - The Legal Principles in the Disposal of Office Property
Part V - Lease Provisions
Part VI - Property and Associated Costs
Part VII - The Steps to Acquiring Offices
Part VIII - Conclusion
Glossary of Terms