Urban Developments: Common issues and how to address them - Part 1

Using a tired, mixed-use retail office building in London as a case study, we look at some of the issues which might be encountered on an urban redevelopment scheme. In this first part, Miri Stickland quizzes Katherine Ekers on the position in respect of existing tenancies.

My retail tenant has gone bust and, whilst some of the office space is vacant, there are a couple of standing tenants left. I am considering converting to predominantly residential use and adding a couple of extra floors on top of the building to maximise my return. In terms of the existing tenants, what should I be considering in my overall strategy for getting vacant possession?

Firstly we need to consider when the leases come to an end. Do they all expire in the next year or two, or have you got a tenant with rights to stay for longer than that?

You can always negotiate with a tenant for them to leave earlier than their lease expiry, but they may not want to go and that is at their discretion. If they do agree to go, they may require some financial compensation in return for giving up their rights to be in the building.

You may, however, find a tenant who actually wants to leave the building and is happy to agree an early surrender with you in return for being released from their future liabilities under the lease to pay rent and other costs.

It is always worth bearing in mind that, at the end of a lease term, a tenant will often have accrued quite significant dilapidations liability, which is the cost of putting the building back in repair and decoration at the end of the term. This means that some tenants will be very happy to be released from those liabilities as well as the obligation to pay the rent for the remainder of the term.

If a tenant wants to stay in the building, do I just need to wait it out until the expiry of the lease term?

Essentially, yes. However, just as with any other commercial negotiation, it is important to understand as much as you can about that tenant’s business and what motivates them. You may be able to reach a sum that they will accept in return for giving up their lease, or you could have something else to offer them. You may have a building nearby to relocate them to, or you may know other landlords with suitable vacant space - so do think outside the box in having those sorts of conversations. Ultimately though, if a tenant has a ten year lease term, they do have a right to be there for ten years unless they're willing to give up those rights.

But once we get to the end of the term they will have to leave?

That won’t necessarily be the case as business tenants can have a right to stay in the premises after the end of their lease term. This is known as "security of tenure" under the Landlord and Tenant Act 1954. The position will depend on whether or not the lease is within the protection of the Act - which is usually easy to establish from a relatively quick review of a lease by your lawyers. Tenants who do have a right to renew have a right to be granted a new lease unless certain conditions can be satisfied by the landlord – one of which is redevelopment. So a landlord can oppose the grant of a new lease on the grounds of redevelopment, but the burden of proving that they do genuinely intend to redevelop is on the landlord. If the tenant puts them to proof, the landlord would need to have absolutely everything lined up to demonstrate it to the court.

Does that mean I need to have planning permission?

It is not an absolute prerequisite, but it would significantly help your case. The process begins with the landlord serving a notice on the tenant, which can be done up to 12 months before the end of the lease term, stating that they don't intend to grant a new lease and they will oppose any renewal of the lease on the grounds of redevelopment. The tenant may choose to accept that notice and leave at the end of the lease term or the notice period specified in the notice. However, if they choose to fight it, then it could take another 12 or 18 months after the end of the lease term to get to the court hearing – at which the landlord would need to demonstrate its intention to redevelop. At that point, the landlord will ideally have planning consent in place, or have submitted a planning application and be able to persuade the court that there are no reasons why consent would be refused.

The landlord would also need to show that they can financially afford to carry out the redevelopment, so they would have to demonstrate that they have the cash reserves or that they can secure bank funding to do so. They would probably have lined up a building contractor and other professionals so that they can show the court that they are absolutely ready to start work and that the only thing holding them up is the existence of this tenant.

So I need to think carefully about timing for service of proceedings if that is the route that I need to go down?

Yes, definitely. There can be a real advantage in getting those sort of steps (planning etc) lined up at an early stage in order to present the tenant with a strong case from the beginning and demonstrate that there is no realistic prospects of success for them. That might persuade the tenant not to bother fighting the court process, given that if they lose they will have to fund their legal costs.

It is worth bearing in mind that you will need to pay the tenant’s statutory compensation in return for them losing their right to renew the lease. This is provided for in the Landlord and Tenant Act 1954 and, depending on how long a tenant has been in the building (including its predecessors in running the same business) you will either have to pay them once or twice the rateable value of their premises.

Does that compensation amount provide a guide for what you might offer the tenant to agree an early surrender?

Yes, that would be a good starting point. You might also factor in the legal costs the tenant would have to incur in fighting the court process. Bear in mind that you may be able to allow the tenant to stay in the premises whilst you sort out things like planning pre commencement conditions and lining up your building contractor. You could move the tenant over to a shorter term, more flexible lease, enabling them to stay in the building for a bit longer in return for giving up their rights to renew.

That would also be a way of ensuring that I have got an interim income stream. What would that kind of arrangement typically look like?

They can be really flexible and it is something that we would definitely recommend the landlord does, if at all possible, because the costs of having an empty building can be quite significant, particularly bearing in mind void rates liability.

You can put in place short term leases with rolling landlord rights to break, on anywhere from one month to six months' notice. Tenants are likely to want a lower rent in return for agreeing that flexibility but, so long as you ensure that those leases are outside of the protection of the Landlord and Tenant Act 1954, you will have complete security that you can get the tenants out by serving those break notices whenever you want to.

Listen now: for further commentary on common issues encountered on urban development schemes, click here to listen to the Forsters More Than Law Podcast.

Urban Developments: Common issues and how to address them - Part 2 - Strategic Planning