A more challenging environment for funding and recent asset management regulatory requirements mean that housing associations are looking increasingly at those commercial premises forming part of their portfolio - both to maximise the return from the assets to assist funding and to ensure compliance.
Over the next few months we will be looking at different aspects of the commercial lease and issues relating to asset management of a commercial portfolio from the perspective of a housing association.
The first topic we will consider is that of security.
Housing associations with commercial premises amongst their assets will be only too aware that a new tenant may not always have a long trading history. Therefore it becomes necessary to consider what options may be available to secure the new tenant’s performance under the lease.
One option is the rent deposit. This is a sum of money, usually equivalent to three or six months' rent, which is set aside in a separate interest bearing account as security for any sum owing and unpaid under the lease, as security for costs relating to any breach of covenant on the tenant’s part, or for use at the end of the term of the lease in the event that there are outstanding payments or issues with repair.
The advantage of the rent deposit, at least as far as the landlord is concerned, is that the funds are readily available to meet potential arrears or costs. A well drafted rent deposit will provide for the deposit to be “topped up” to its original level when funds have been deducted and to be increased in line with any rent review. There will be further management requirements in monitoring a rent deposit and this needs to be factored in.
From a tenant’s point of view a rent deposit can be seen as “dead money” that could otherwise be invested in their business, so a request for a rent deposit may not always be greeted with open arms. Market practice would suggest that tenants are accepting the obligation to provide a rent deposit as part of the process of taking a new lease.
The duration of the arrangement is generally until the first lawful assignment of the lease by the tenant, although some rent deposits provide a financial formula which can trigger release, usually linked to assets/profits equalling a set multiple of the rent over a period of three to five years.
An alternative security to the rent deposit may be the provision of a personal guarantee by a director or directors (in the case of a company) or an individual (in the case of a sole trader, for example).
A tenant may view the personal guarantee as more beneficial as there is no initial cost to them, but from a landlord’s point of view a personal or corporate guarantee will only be as worthwhile as the financial substance of the person or company giving the guarantee. Suitable financial references will be vital in assessing this. Beyond that, from a landlord’s perspective, there may be costs involved in enforcing the guarantee which, whilst recoverable, will mean that there is a time lag in recovering full costs.
A guarantee will usually provide that in the event of tenant insolvency the landlord can request the guarantor to take a new lease for the residue of the term. This may be viewed as advantageous to a landlord in as much as the guarantor will usually be of greater covenant strength than the tenant.
The question of security will not only be addressed at the initial letting of commercial premises but also upon any assignment or underletting. A well drafted lease will give the landlord the opportunity to request either, or sometimes both, a rent deposit or guarantee as a condition of assignment, or the ability to demand that an undertenant provides a guarantor where reasonably required.
A further level of security is available on assignment of a commercial lease due to the creation of the Authorised Guarantee Agreement (AGA) by the Landlord and Tenant (Covenants) Act 1995. The AGA is the outgoing tenant’s guarantee that the incoming tenant will observe and perform the tenant’s obligations under the lease. As with any guarantee of a commercial lease, the AGA will provide that a landlord may require the guarantor to take a new lease in the event of the insolvency of the incoming tenant. The outgoing tenant’s obligations under the AGA will last until the next lawful assignment of the lease.
The level of security that a landlord might be able to negotiate will as always depend upon the market and the need to secure a tenant, as against the tenant’s desire to secure the premises. Landlords would be well advised to ensure that their initial letting requirements and their leases provide them with the ability to ensure that their position is adequately covered from the outset.