SQE 1 Grant of a lease - Property Practice

Who are commercial landlords

Private investors and institutional investors

What will be considered in the process of asset management

Granting a lease to a new tenant

Considering applications by the tenant during the lease; for example, to alter the premises

Advising on breaches of the lease, such as failure to pay the rent or letting the premises fall into disrepair

Or dealing with the issues that arise when a lease comes to an end and the tenant is leaving or wants a new lease.

What is a lease defined as

The grant of a right to the exclusive possession of land for a determinate term less than that which the grantor has himself in the land

If the owner is a freehold their interest is in perpetuity, and therefore it doesn't matter how long a fixed term is (10 years, 99 years, 999 years or even more), it will be less than their interest.

Also - A lease is the document that creates a leasehold interest.

At its simplest it may just state the contractual term and rent payable

What are the key elements of a lease

Exclusive possession

Exclusive possession is an essential ingredient of a lease (distinguishing it from a licence).

Fixed term or periodic tenancy

The lease must be for a fixed term (six months, 5 years, etc) or a periodic term (a weekly tenancy, monthly tenancy, yearly tenancy etc).

What are the formalities for creating a lease

A legal lease must be created by deed if the term is over 3 years.

A tenancy of 3 years or under may be created in writing, or even orally.

What are the main objectives of landlords and tenants when it comes to leases

The landlord will want a lease that ensures the premises are:

> insured

> kept in repair

> only used for the permitted purpose

The landlord will also want:

> to control whom may occupy of the premises (eg, if the tenant tries to pass the lease on)

> to have a say over how the premises are altered by the tenant

> to increase the rent in line with market rent over the contractual term of the lease (by way of rent review)

The tenant will want a lease that:

allows the tenant to use the premises for its intended purpose

has a contractual term

provides some flexibility if circumstances change

Also want:

Terms that aren't onerous

Provisions that allow for a steep rise in rent

Separation - Term of lease ,break clauses, rent and rent review

What is the key nature of a lease term

Must be determinate

When might the term of a lease start

Completion or later or earlier than the lease date

What is a reversionary lease

The term may also start after the lease is dated

When should you look at when determining when a lease starts

'from and including' a certain day of the year, the term expires on the day before that day of the year in the relevant year (more common in practice)

For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23 March 2029

Or

If the term of the lease is 'from' a certain day of the year, the term starts the day after that day, and so expires on that day of the year in the relevant year (less common in practice)

For example, a lease with a term of 10 years from 24 March 2019 will start on 25 March 2019 and expire on 24 March 2019

What is a break clause and what effect does it have

Allows the tenants an landlords to end their lease earlier

Can specify the date or have a rolling break (eg, any time after the fifth anniversary of the term commencement date)

A break clause can allow both parties to exercise it or only one of the parties

if the lease does not include a break clause, in general neither landlord nor tenant can bring the lease to an end before the end of the fixed term without the agreement of the other.

What are the categories that leases are likely to fall into when it comes to rent

> a short lease with a market rent;

> or a long lease with a ground rent.

How is rent in commercial leases set out normally

Commercial leases are usually short leases (up to 15 or 20 years) with a market rent (also known as rack rent).

A premium (lump sum) is not usually charged on the grant of a commercial lease.

How is rent in residential leases set out normally

Residential leases may be long leases (say 99 or 999 years) with a ground rent (that may be a low sum, say £150 per annum or even a peppercorn each year).

The first person to rent the property may have to pay a premium to the landlord

How is rent normally paid in a commercial lease

Expressed yearly and paid quarterly

divided into approximate quarters, which may run from the traditional quarter days (in bold), based on religious festivals, as follows:

25 December to 24 March25 March to 23 June24 June to 28 September29 September to 24 December

Rent is usually due in advance on the quarter day - for example, on 25 March for the whole period up to and including 23 June

If lease silence on payable in advance then rent is paid in arrears. Most common in residential long leases.

Normally includes VAT

When happens in regard to rent when a lease is ended earlier

the quarter will be apportioned, so the tenant will only pay the appropriate portion of the rent (for example, if the tenant's lease starts one month into the quarter, they will pay approximately two thirds of that quarter's rent).

What are the different ways in which rent may be reviewed

Types of rent review

No implied right for the landlord to be able to increase the rent. An FRI lease of 10 years or more will usually contain a rent review clause - keep up with market

Stepped rent

The lease may set out, for example, a yearly rent of £25,000 for the first two years, a yearly rent of £30,000 for the next two years, and so on...

Turnover rent

The rent may be calculated based on the tenant's turnover at the property. This is mostly commonly seen with retail leases (eg, shops).

Index-linked rent

The rent is increased by reference to an agreed measure of inflation, such as the retail prices index.

Open market rent review

This is the most common type of rent review adopted by FRI leases, and involves ascertaining the rent based on comparable premises and certain principles.

What will occur under the open market rent review process

> Upwards only rent review. If the market prices go down the landlord will keep the same rent.

> Can agree or normally an agreed mechanism i.e. specialist valuer:

1. Considers the rent payable for comparable premises and terms of the hypothetical lease

What assumptions will a valuer take in consideration when looking at a hypothetical lease

Assumptions:

the premises are vacant and available

there is a willing landlord and a willing tenant

same terms

Covenants have been compiled with

Property had been instated if it has been destroyed

Disregards:

Disregards generally operate to ignore what the tenant has done voluntarily, and not as an obligation of the lease.

Tenants occupation

Goodwill

What happens after rent review

Agreement or Valuation:

Parties agree on the new rent, or a valuer determines it.

Rent Review Memorandum:

Documented in a concise rent review memorandum, typically a single-page agreement.

Signing: Both landlord and tenant sign the memorandum.

Storage: Kept alongside the lease for future reference.

Stamp Duty Land Tax (SDLT) or Land Transaction Tax (LTT):

Before 5th Anniversary: Tenant may incur additional SDLT or LTT if the review occurs before the 5th anniversary.

On or After 5th Anniversary: No further SDLT or LTT for the tenant.

Backdating New Rent:

If the new rent is agreed post the set review date, it's backdated.

Consequence: Tenant pays a supplemental amount with interest, as per the lease terms (non-punitive rate).

Rent review potential tax

The new rent is documented in a rent review memorandum.

If the rent review is before the 5th anniversary of the term commencement date, the tenant may have to pay further Stamp Duty Land Tax or Land Transaction Tax.

If the rent review is on or after the 5th anniversary of the term commencement date, the tenant will not have to pay further SDLT or LTT (s this is calculated on the first five years' rent)

What is the Code for Leasing Business Premises

The RICS Code for Leasing Business Premises (2020) promotes fairness and transparency when negotiating commercial leases.

Key points:

• Heads of Terms: Written heads of terms should be agreed before drafting the lease.

• Fair negotiations: Parties should negotiate openly and fairly.

• Rent and rent reviews: Terms should be clearly stated.

• Break clauses: Conditions for exercising break rights should be clear and reasonable.

• Repairing obligations: Should be appropriate to the property's condition and the lease terms.

• Assignment and subletting: Restrictions should be reasonable and clearly explained.

• Security of tenure: Tenants should be informed if the lease is to be excluded from the Landlord and Tenant Act 1954.

• Not regulation. Best practice.

What is the purpose of the Code or Leasing Business Premises

'improve the quality and fairness of negotiations on lease terms'

and

'promote the issue of comprehensive heads of terms that should make the legal drafting process more efficient'

Who does the code apply to

Property professionals, whether property firms or in-house property specialists who deal with the letting of commercial property, will be RICS regulated.

Mandatory requirements and good practice

Mandatory requirements

Mandatory requirements are indicated by the word 'must'. RICS members and regulated firms must follow them.

What is contained in Code's mandatory requirements

Mandatory requirements

Lease negotiations must be approached in a constructive and collaborative manner

An unrepresented party must be advised about the existence of the Code and recommended to seek professional advice

The landlord (or its letting agent) is responsible for ensuring that heads of terms compliant with the Code are agreed before the draft lease is circulated

Good practice

Code specifies certain areas which must be covered in the heads of terms. These include:

extent of the premises

length of term and break rights

rent and rent review (including basis for rent review)

repairing obligation

rights to assign (transfer to a new tenant) or underlet the lease

permitted use of the property (and whether tenant can change it)

rights to alter the property and any obligations to put the property back in its original state

Good practice

RICS members and regulated firms must follow them unless there are exceptional circumstances

(and they may need to be justified to the RICS).

Good practice of the code

1. Premises

Heads of terms: Clearly define the demise, provide a lease plan, and specify tenant rights, such as access, water, and electricity.

2. Length of Term, Renewal, and Break Rights

Head terms: Specify the term length, renewal options, and break rights, including acceptable conditions for exercising breaks.

3. Rent and Rent Review

Head terms: State initial rent, payment frequency, VAT inclusion, and potential rent-free periods. Address rent review details, such as method and frequency.

4. Landlord's Title

Specify the landlord's responsibility for obtaining necessary consents for lease grant (such as from a superior landlord, mortgagee or any other third party).

5. Repairs

Tailor the tenant's repairing obligation based on the term and premises condition. Consider the fairness of the obligation, especially for shorter tenancies(unfair for tenant on 6month to take full-repair obligation) . Include a schedule of condition for qualified repairing obligations.

6. Newly Built Premises Protection

Provide appropriate protection for tenants against inherent construction defects in newly built premises.

7. Insurance and Damage

Address rent suspension in case of premises damage due to insured or uninsured risks, excluding tenant negligence.

Code of Leasing Business Premises

> Tenant should know of the code

> Landlord must ensure head of terms compliant

> Head of terms: (1) Premises and specified right within (2) Rent and Rent Review issues (3) Term, Renewal and Break Right issues

> Repairs: Fair - will depend on the length on the term

> New built premises protection

> Insurance and damage: Address rent suspension related to this

Separation - Grant of a lease procedure

What will happen in the pre-exchange procedure for leases

Drafting the lease

> The landlord's solicitor will draft the lease based on the heads of terms. The solicitor may use a generic precedent lease. Or Tailored with past lettings as a base

Agreement for lease

> Agreement for lease will not often needed - parties' solicitors will simply complete once the tenant's solicitor is happy with their title investigations and form of the lease is agreed.

> An agreement for lease is needed where the parties want to commit to completing the lease, but either are not yet ready, or there are conditions that need to be satisfied.

Lease process

Key terms

Engross: This means to prepare a final copy for signature (eg, on good quality paper and bound. This copy is referred to as an engrossment.

Original: This is the engrossment of a lease that is executed by the landlord.

Counterpart: This is the engrossment of a lease that is executed by the tenant.

Pre-exchange

• Heads of Terms: Agree key lease terms (rent, duration, break clauses, repairing obligations).

• Investigate title: Tenant's solicitor checks the landlord's ownership and right to grant the lease.

• Searches and enquiries: Carry out relevant property searches and raise CPSE enquiries.

• Draft lease: Landlord's solicitor prepares the lease; tenant's solicitor reviews and negotiates it.

• Lender's consent: Obtain consent from the landlord's mortgage lender if required.

• SDLT: Consider SDLT liability based on any premium and the rent payable.

• Report to client: Explain lease obligations, risks and obtain approval to proceed.

• Pre-exchange checks: Ensure necessary documents, finance and any required consents are in place.

What investigation of title, searches and enquiries

Deduce title > Title to grant the lease + freehold covenants

Raise CPSE1 enquiries (as does a buyer's solicitor in a commercial freehold transaction) but will also raise CPSE3 enquiries which are specific to the grant of a lease

The tenant's solicitor should raise the same searches as they would if they were buying the freehold.

May not be justified for a short lease

What enquires are specific to a lease

CPSE3 enquiries

What happens in the exchange

> the landlord's solicitor and tenant's solicitor exchange in similar manner as for a freehold contract

(usually adopting Law Society B)

> No deposit is usually payable

> The agreement for lease may set a fixed completion date, but more likely will set out what conditions need to be satisfied and by when for completion to take place

> The agreement for lease will usually have a draft of the agreed form of lease annexed to it, so it can only be exchanged once the terms of the lease have been agreed

Is a deposit payable for a lease

> No deposit is usually payable

Pre-completion

Landlord's solicitor

Prepare original and counterpart lease, obtain landlord's signature to original and send counterpart to tenant's signature

Prepare and send completion statement, detailing the money due on completion (eg, any apportioned annual rent, service charge and insurance rent)

Tenant's solicitor

Arrange for tenant to sign counterpart lease

Obtain funds from client needed to complete as per completion statement

Raise pre-completion searches

What is the completion statement

A financial statement prepared before completion showing the amount the tenant must pay to the landlord to complete the lease.

It typically includes:

• Rent: Any rent payable in advance.

• Rent deposit: If required under the lease.

• Service charge: Any service charges payable in advance.

• Insurance rent: Any insurance contributions due.

• VAT: Where applicable.

• Other sums: Any agreed payments due on completion.

What happens in the completion process

the tenant's solicitor sends the landlord's solicitor the completion monies

the landlord's solicitor and tenant's solicitor agree over the telephone to complete and date the executed leases that they are holding

the landlord's solicitor and tenant's solicitor send the completed original and counterpart to each other

Post-completion

Landlord's solicitor

Send summary of main provisions of lease to client

Tenant's solicitor

Arrange to submit SDLT or LTT return and pay appropriate SDLT or LTT if necessary - SDLT 5

Register lease if necessary - Lease copy and AP1 form.

Will receive updated copies.

Registration of leases

Does not need to be registered. Cannot be noted against the landlord's title.

Procedure for registering a lease

If a lease is registrable, then an OS1 (lease of whole) or OS2 (lease of part) search should have been carried out before completion to give priority.

The tenant applies to register the lease using form AP1 (if the landlord's title is registered) or FR1 (if the landlord's title is unregistered).

A certified copy of the lease may be scanned and submitted electronically.

If the landlord's freehold title is charged, then a letter of consent from the lender will also be needed.

On completion of the application, the tenant's solicitor will receive two official copies (the new leasehold title and the updated landlord's title)

Note that if the tenant is a company, then usually the lease will not be charged, and so there is no need to register the transaction at Companies House.

OS3 for the non-registrable

When should you include when registering a lease

AP1 or FR1

Lease copy

Consent from the lender

What happens if the rent review date is missed

Rent is paid at the normal rate and once revised, payments will be backdated to take in to consideration the increase in the rent

Registration of leases 3-7 years

Does not need to be registered.

Can be noted (notice) against the landlord's title (it will appear in the schedule of leases to the landlord's freehold title).

Registration of leases 7+ years

Must be registered at the Land Registry (and will be given its own title number).

Will be noted against the landlord's title (it will appear in the schedule of leases to the landlord's freehold title).