Life has been made increasingly hard for residential property portfolio holders with the phasing out of tax relief on buy-to-let mortgage interest from the 2016/2017 tax year and the SDLT surcharge on additional properties of 3% was also introduced from April 2016. This year will see further changes including the requirement for mandatory electrical safety checks from 1st July 2020 for all residential tenancies (previously required just for HMO’s) and the outcome of the Government’s “New Deal for Renting” consultation on the proposed ending to “no-fault” evictions under Section 21 of the Housing Act 1988, meaning Landlords could be faced with increased costs and longer legal processes to remove problem tenants.
If you are a residential Landlord, you might be considering making your first commercial property purchase, so here are a list of the key differences between residential and commercial lettings you should know.
Tenant Covenant Strength
Whilst the residential market is fairly buoyant, finding good quality commercial tenants can be tricky so you need to make sure that any proposed Tenant is financially sound. So, if you are buying a freehold subject to a lease or granting your first commercial tenancy, be sure to carry out a thorough due diligence exercise beforehand. Director guarantees, rent deposits and previous Landlord references are all commonplace requests when negotiating new lease terms or agreeing the terms of the assignment of an existing lease.
Repair
Here is the good news, if you are leasing the whole of a building it is commonplace for the commercial Tenant to take on “full repairing” liability. This means that they are responsible for the whole of the property (from the foundations to the rafters) and for every issue in between, including all regulatory compliance. There are also various methods by which a commercial Landlord can make sure that a Tenant complies with those obligations, both during the term and after the lease has come to an end, including doing the works yourself and recharging the cost back to the tenant (provided the right notice has been served on the Tenant and subsequently ignored). If you buy a building with a number of commercial/or residential units then you will retain some responsibility for maintaining the common parts. This is usually married with a Service charge recovery clause so you should never be financially out of pocket for any repairs you are required to do.
Alienation
This is assignment, subletting or charging of the property. Whereas most residential tenancies are for relatively short-term periods and simply end if the property is no longer required, commercial leases tend to be longer and are therefore capable of being passed on to new “owners”. As assignment means the whole of the leasehold interest is passed from one tenant to another, subject to the Landlord’s consent, which must not be unreasonably withheld. Most leases do allow a Landlord to impose other conditions including the requirement for an authorized guarantee agreement. This is where the original Tenant will guarantee the performance of the incoming tenant, for as long as the incoming Tenant holds the lease. If the lease is for a long time, this may happen more than once during the lease term and so you may end up with an entirely different tenant occupying the property at the end of the lease term than when you started.
Subletting means the original tenant stays ‘on the hook’ as it were for the main rent and sub-lets the property to a sub-tenant. The original Tenant is still your primary debtor, even though they don’t physically occupy the Property. Subletting is usually restricted to one sub-letting only. Be aware though that if your Original Tenant (and now intermediate Landlord) gets wound up or disappears, the sub-tenant may become your direct tenant, so a thorough vetting process should be included in the lease for you as Head Landlord.
Statutory Protection and Termination
Leasing business premises can come with its own risks as Tenants can acquire protection for business tenancies under the Landlord and Tenant Act 1954, meaning that at the end of the fixed term, the Tenant will be able to legally procure a renewal of the tenancy, save where a landlord can demonstrate one of the 5 grounds for refusing to grant a new lease. The good news is you can insist that any letting is “contracted out” of this statutory protection, giving you more flexibility. But beware letting a contracted out tenancy overrun the fixed term, otherwise you might inadvertently grant a new protected tenancy.
Business Rates
Business rates are entirely separate from council tax and are payable on non-domestic premises. Under commercial leases (like residential tenancies) business rates are paid by the occupier. Landlords of commercial premises can apply for 3 months’ empty property relief on business rates if the Tenant has left a property empty at the end of the lease term and can include a repayment clause if the Tenant has used the empty rates relief for itself. However, you should note that the rates are substantially higher that council tax so commercial Landlords may need to keep a reserve on hand for this.
Council tax is payable even if a residential property is empty, but the level paid is dependent on the local authority and whether a discount may apply. Circumstances depend on the local authority involved.
Conclusion
Whereas residential tenants may have you running around fixing problems with their properties, you may not hear a peep from your commercial tenants for many years. The benefit of commercial property ownership comes with the ability to pass on the repairing and statutory obligations on to the Tenant. However it is a substantially riskier game if you lose a Tenant and a replacement cannot be found. Higher rate bills on empty properties and a Tenant who doesn’t have the money for dilapidations bills mean it can hit your pocket harder when times are tough.
If you would like to discuss your first move into commercial property ownership then please call the Commercial Property team on 01473 298250 or email CommProp@prettys.co.uk.
