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The central London market has readjusted to a very different economic outlook today by comparison with eighteen months ago and now favours the tenant, or does it? Unlike earlier cycles where supply increased significantly and take up remained sluggish for a long while afterwards, this time around, supply has increased by a much lesser degree, and although take up is nowhere near its earlier levels, deals are still being done. Although rents have fallen back significantly from their peak in April 2008, an occupier looking for grade A space in the West End, will be surprised by some of the quoting rents still being advertised. The City offers better value by comparison, but even here the general view is that the best of the market, from an occupier standpoint, maybe starting to fade. So if you are an occupier looking for space, what should you be able to achieve in the way of incentives, when negotiating a new lease. The concession of a rent free period is still an automatic feature of most office lettings, other than in very competitive circumstances, or when a lease is assigned. It was originally intended to cover the period required for a tenant to complete partitioning and any other fitting out works, but is now generally recognised, as being an incentive as well. It is always difficult to say precisely how long this should be, because so many other aspects of the deal will influence what is agreed. However, assuming a five year lease without a break, 12 months should be achievable in the West End but 15 months or more can be achieved in the City. The longer the commitment the tenant gives, the longer the rent free period is likely to be. Another incentive for the tenant to pay a higher rent is the offer of a shorter lease or the added flexibility afforded by a tenant's break option. It is now standard practice for small/medium size lettings to be based on a five year term or less and it should be possible to agree a break option after three years, although for larger lettings landlord's will still resist this. Break options are usually conditional to a greater or lesser degree. Penalty payments are sometimes attached and you may find the rent free period is either reduced or split either side of the break date. Certain lease compliance conditions can make it difficult for a tenant to serve a valid break notice and must be avoided. Head lease rent reviews usually influence the timing of a break option in the case of a sub-lease, because the same rent review pattern is commonly imposed on the sub-tenant by virtue of the head-lease requirements for sub-letting. This is a good moment for both parties to have a break, since it avoids the complications of going through the process of a rent review. A tenant's break option is a very valuable benefit and all the more so when it looks likely that rents will fall further. This is the only practical safety net for a tenant who signs a lease in a falling market and subsequently needs to dispose of it. Even if a significant rent penalty is attached, it is often still good value, when all the ongoing costs associated with the lease are taken into account, regardless of the sub-letting or assignment alternatives. This is now even more relevant, given the withdrawal of the 50% relief for empty property rates. Shorter, more flexible leases are now an established part of the market and it is unlikely this will change. Revised lease accounting standards are being proposed by the International Accounting Standards Board, which would mean the full cost of occupational leases will need to be treated as both assets and liabilities for balance sheet purposes from 2013. However, short leases can still include terms more appropriate for a much longer lease, often because they follow a head lease. The condition at the start of the lease is not necessarily the basis for determining what reinstatement the tenant will be expected to carry out before handover on expiry. This point should be considered carefully, particularly in the context of second hand accommodation. Often, any reinstatement can be limited by an agreed schedule of condition at the outset. On the other hand, if the space is new, the tenant will incur fitting out costs, which may have to be written off over a relatively short period, added to which there is the cost of reinstatement on moving out, so a short lease can have disadvantages as well. Service charges are another area where a tenant can be exposed to above average costs for a short period, particularly in older buildings. The lease might only be for five years but if the landlord needs to replace the lift in year three, a full contribution will still be demanded. Therefore a service charge cap can be a valuable concession to agree as part of the deal. Another influence on the length of leases has been the introduction of Stamp Duty Land Tax. Whereas the old stamp duty was about 2% of the average annual rent, under the new system it is 1% of the total rents due including any VAT, discounted by a variable percentage to arrive at a net present value figure. The threshold at which the tax becomes payable favours lettings of smaller units but few transactions in London are exempt and the duty payable by comparison to the old system can be significantly more. So what about rent reviews? The upwards only rent review clause, (still usually on a five yearly basis), has survived despite several market cycles and government pressure for lease reform. A coincidental break option is still the closest most tenants will get to achieving an upwards/downward result, given a degree of brinkmanship and assuming the market evidence is favourable! Signing a lease is very much easier than getting out of it later on. So a prospective occupier should always consider appointing an agent to act for them in order to be confident of getting the best deal. After all, the Landlord does!
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