Unpublished draft : not for publication

Summary

Lease length, rent reviews and repair obligations affect the income, costs and exit options of a mixed-use property. Investors should review these terms with the tenant covenant, rent evidence, building condition, planning position and compliance records.

A long lease is not automatically secure. A lease with a weak tenant, above-market rent, generous incentives, broad break rights or significant repair exposure may carry more risk than its headline term suggests.

Gross Development Value and residual land value should remain hypothetical unless supported by planning, design, cost plans, finance terms and comparable evidence.

1. Lease length and income security

The contractual term is the period stated in the lease. The unexpired term is the period remaining from the review date or acquisition date.

These are not the same. A 15-year lease with 10 years remaining is a different investment from a new 15-year lease.

Investors should identify:

  • The lease start date.
  • The contractual expiry date.
  • Any tenant or landlord break date.
  • Notice periods and break conditions.
  • Renewal rights.
  • Whether the lease has security of tenure.
  • Whether vacant possession can be obtained at expiry.

A longer unexpired term may support income visibility, lender confidence and resale liquidity. It may also reduce the risk of an immediate void. However, the effect depends on the complete lease package.

A lender or valuer may also consider:

  • The tenant’s financial strength and trading record.
  • Rent payment history and arrears.
  • Whether the passing rent is supported by market evidence.
  • Rent-free periods and other incentives.
  • The remaining term after the next break.
  • Repair and compliance liabilities.
  • The permitted use and planning position.
  • The quality of the building and its services.

A tenant break can reduce income security before the contractual expiry date. A lease expiry does not always create vacant possession. If the commercial tenancy has security of tenure under Part II of the Landlord and Tenant Act 1954, the tenant may have rights to remain and seek a new tenancy. If those rights have been excluded, the contracting-out procedure must have been completed correctly.

The terms should be reviewed by a solicitor. Investors should not assume that a reference to “contracted out” is sufficient.

2. Rent reviews and effective rent

Rent reviews change the rent during the lease. The mechanism is contractual and must be read in full. No review structure should be treated as standard or guaranteed.

Common approaches include:

  • Open-market review: rent is assessed by reference to market evidence at the review date.
  • Index-linked review: rent changes by reference to an index, such as CPI or RPI, subject to the wording.
  • Fixed increases: predetermined increases apply on stated dates.
  • Turnover-linked rent: rent is calculated partly or wholly by reference to the tenant’s turnover.
  • Caps and floors: increases or decreases may be limited by agreed maximums or minimums.
  • Hybrid provisions: a lease may combine a fixed increase with an index or market review.

Check the review dates, valuation assumptions and disregards. An open-market clause may disregard the tenant’s improvements, goodwill or occupation. The wording may also address the assumed lease length, permitted use, incentives and repairing obligations.

An upward-only clause, where applicable, may prevent the rent from falling even if market rent has reduced. It may allow the rent to increase or remain unchanged. It does not guarantee that the rent will rise in economic terms.

The RICS Code for Leasing Business Premises recommends clear heads of terms covering rent, incentives and review provisions.

Passing rent should be tested against comparable lettings. Do not rely only on the headline figure. A commercial lease at £25,000 per year may include:

  • A rent-free period.
  • A landlord contribution to fit-out.
  • A stepped rent.
  • A concession or side letter.
  • An agreement to meet service charge costs.
  • A temporary rent reduction.

For example, a five-year lease at £25,000 per year with six months rent-free produces total base rent of £112,500 over the term. The average rent is £22,500 per year before other costs and incentives. This is the net effective rent for that limited illustration, not the contractual headline rent.

3. Repair obligations and building condition

A full repairing and insuring lease, often called an FRI lease, may place substantial repair, maintenance and insurance costs on the tenant. The exact scope depends on the wording and the extent of the premises.

An internal repairing and insuring arrangement may limit the tenant’s direct responsibility to the internal parts of the unit. The landlord may retain responsibility for the structure, roof, foundations, external walls and common parts, with costs recovered through a service charge.

Review responsibility for:

  • The roof and gutters.
  • Structural walls and foundations.
  • Shopfronts, windows and doors.
  • Plant, heating and ventilation.
  • Electrical and water systems.
  • Fire alarms and emergency lighting.
  • Common entrances, stairs and access routes.
  • Drainage and external areas.
  • Insurance and reinstatement.
  • Compliance and improvement works.

A schedule of condition records the property’s state at the start of the lease. It may limit the tenant’s obligation to return the premises in a condition no worse than that recorded. It does not automatically remove every repair obligation. The lease must state how the schedule operates.

Repairs can remain a landlord risk even where the lease appears to pass responsibility to the tenant. The tenant may be insolvent, in arrears or unable to fund the works. The landlord may have to enforce the lease, fund works during a vacancy or manage a dispute over the scope of the obligation.

Other risks include:

  • Exclusions from the tenant’s demise.
  • Shared structural elements.
  • Common parts.
  • Landlord access rights.
  • Reinstatement obligations.
  • Latent or inherent defects.
  • Uninsured damage.
  • Service charge recovery limits.
  • Repair obligations that are difficult to enforce.

In a shop-and-upper property, the commercial lease and residential tenancy should be reviewed separately. The shop tenant may be responsible for the shop interior, while the landlord remains responsible for the upper residential accommodation, shared access and building structure. The residential units may be let under separate assured shorthold tenancies, with separate repair, gas, electrical, licensing and management requirements.

Check current MEES guidance for non-domestic property and residential landlord safety responsibilities.

4. Lease-review table

Item What to check Why it matters Possible risk
Term Start date and contractual length Establishes income period Shorter term than expected
Unexpired term Time remaining at acquisition Supports income analysis Near-term reletting risk
Break Date, notice and conditions May end income early Break may be exercised
Expiry Contractual end date Identifies renewal or void timing No vacant possession
Rent review Date, basis and formula Determines future rent Dispute or rent reduction
Rent-free period Length and incentives Tests net effective rent Headline rent overstated
Deposit/guarantee Amount, scope and release Supports recovery Security may be limited
Arrears Receipts and payment history Tests covenant quality Existing cash-flow problem
Assignment/subletting Consent and conditions Affects flexibility Difficult exit or weaker occupier
Repair Internal, structural or FRI Allocates capital costs Unfunded works
Insurance Insured risks and premium recovery Protects the building Coverage gap or high premium
Service charge Scope, cap and historic costs Funds shared works Major unexpected charge
Permitted use Lease and planning use Supports lawful occupation Enforcement or reletting issue
Alterations Consent and approval records Confirms authorised works Reinstatement cost
Reinstatement End-of-term obligations Estimates exit cost Dilapidations claim
Security of tenure 1954 Act protection or exclusion Affects possession Renewal and compensation risk

5. Hypothetical screening example

The following is a hypothetical example, not a forecast or valuation.

Assume:

  • Purchase price: £1,000,000
  • Ground-floor commercial rent: £25,000 per year
  • Commercial lease unexpired term: 10 years
  • Residential upper income: £35,000 per year
  • Total gross income: £60,000 per year

Initial gross income screening is:

£60,000 ÷ £1,000,000 = 6.0%

This is not a guaranteed return. It excludes finance, tax, operating costs, insurance, service charges, voids, repairs and other expenses.

If the commercial tenant exercises a five-year break:

  • Commercial income may reduce from £25,000 to £0.
  • Residential income remains £35,000, assuming no other change.
  • Gross income screening becomes £35,000 ÷ £1,000,000 = 3.5%.

If a 5% commercial rent review applies and the tenant remains:

  • £25,000 × 1.05 = £26,250 commercial rent
  • Total gross income becomes £61,250
  • Screening percentage becomes 6.125%

If the property incurs a £40,000 repair bill:

  • £60,000 gross income less £40,000 repair cost = £20,000 before other expenses for that year.

If the commercial unit is vacant for six months:

  • Six months of £25,000 annual rent equals £12,500 lost income.
  • Gross income before other expenses becomes £47,500.
  • Screening percentage becomes 4.75%.

If the £40,000 repair occurs in the same year as the six-month void:

  • £47,500 less £40,000 = £7,500 before other expenses.
  • This is not an annual return calculation.

Lease quality may affect yield and capital value. It does not guarantee yield compression or an increase in value. A formal valuation requires appropriate evidence and a qualified valuer.

6. Structure, allowances and tax planning

Investors should consider whether an acquisition is held through a limited company, LLP or another structure. A limited company may provide a separate legal entity and can be relevant to corporation tax and lender requirements. An LLP has separate legal identity features but is generally taxed through its members. The commercial result depends on ownership, funding, profit allocation and the investor’s wider position.

Capital allowances may apply to qualifying plant and machinery fixtures, such as certain electrical, heating, fire alarm or fitted systems. The treatment is technical. On an acquisition, the buyer should investigate whether the seller pooled qualifying expenditure and whether a valid election is required. See HMRC capital allowances guidance and what can be claimed.

Tax-advantaged strategies may include using qualifying capital allowances, pension structures such as an SSAS or SIPP where permitted, or selecting an ownership structure suited to the investor’s objectives. Restrictions, connected-party rules, borrowing limits, tax charges and personal circumstances apply. These are not automatic benefits and require independent tax advice before commitment.

7. Investor action plan

  1. Obtain all leases, licences, ASTs, rent schedules, side letters and variations.
  2. Verify rent receipts, arrears, deposits and guarantees.
  3. Instruct a solicitor to review break, review, repair, alienation and security-of-tenure clauses.
  4. Commission a building survey and schedule of condition.
  5. Reconcile lease obligations with physical condition and planned capital expenditure.
  6. Check EPC and MEES, fire safety, gas and electrical records, insurance and licensing.
  7. Stress-test voids, rent reductions, delayed reviews, tenant failure and major repairs.
  8. Consider the ownership structure, capital allowances and any proposed tax strategy with an adviser.
  9. Obtain lender and valuation advice before committing.

Disclaimer

This article is for information only. It is not financial, tax, legal, planning, valuation, mortgage or investment advice. It is not an offer, valuation or recommendation. Returns are not guaranteed. All figures and property information are hypothetical or require independent verification. Obtain advice from appropriately qualified legal, tax, surveying, valuation and lending professionals before making a decision.

For further information, contact support@realtypackaging.co.uk, Rachel on +44 20 4513 2218, or visit https://www.realtypackaging.co.uk.