In recent years, the frequency of triple net lease agreements has increased steadily on the Swedish property market, with properties covered by such agreements becoming more attractive as investment objects. At the same time, we see a growing imbalance with tenancy law. Do such agreements actually comply with the Rent Act?
The trend towards triple net agreements generates a significant amount of work relating to transactional issues as well as drafting and signing lease agreements. For example, take Prologis’ acquisition of logistics properties from Bockasjö and Alecta in April 2019. This transaction included 11 logistics properties located in the middle and south of Sweden, with a total lettable area of approximately 295,000 square meters.
The expression triple net lease refers to an agreement under which the landlord to the tenant transfers three major cost items that normally, in traditional lease agreements, are carried by the landlord. The three cost items are maintenance, property tax and insurance.
It’s been customary on the Swedish rental market for commercial lease agreements that the tenant pays compensation to the landlord for the premises’ share of the property’s property tax.
With maintenance, traditional allocation practice holds the tenant is responsible for and shall pay the costs for maintenance of the property’s interior such as floor surface, walls and ceiling, and furnishings and fixtures provided by the landlord specifically for the tenant’s business. The landlord is responsible for and pays the costs for all other maintenance of the property. This allocation of responsibilities and costs is always an important issue when negotiating a lease agreement.
Regarding insurance, the tenant is normally obliged to insure the premises and its business, and the landlord is responsible for ensuring that a customary property insurance policy is in place.
When these agreements are used
One example of a situation when it’s common to use variants of a triple net agreement is when the parties have agreed on a sale and leaseback arrangement.
In this arrangement, the property owning company sells the property to, for example, a property fund or similar investor. Simultaneously, the parties enter into a lease agreement with a validity period of normally 15-25 years, in which the seller becomes a tenant who continues to conduct its business in the premises. The seller benefits from this arrangement, since capital is released through the sale of the property, but continues to conduct its business without having to vacate the premises. The new owner considers the arrangement to be a pure capital investment and seldom has the resources or interest to conduct traditional property management.
“Some triple net agreements contain obligations for the tenant to pay full rent regardless of the condition of the premises.”
A presumption for such an arrangement is that the new owner must not bear any other costs for the property other than the capital cost for the acquisition. Consequently, the parties agree that all responsibility for the maintenance and all costs related to the property shall be incumbent on the tenant.
Another situation in which triple net agreements have become more common is when the agreement regards a so-called “build to suit lease” arrangement. This is when a landlord builds a separate building completely fitted for a specific tenant’s business, often in accordance with the tenant’s own specifications and drawings.
This kind of arrangement is common when properties for logistics and manufacturing are let. Even in these cases, it’s become more usual that the landlord is not a property owner in the traditional sense but purely an investor who, just in the case of the sale and leaseback arrangement, doesn’t want to be responsible for maintenance or bear costs other than the capital cost. Furthermore, when it comes to a build to suit lease arrangement, the property owner often takes a greater risk, since a custom fitted building is normally more expensive to adapt to a new kind of business than the business the building was originally constructed for. In some extreme cases it may be necessary to tear down the building and construct a new one when the lease term has expired, if the original tenant is unable to continue to conduct its business in the building.
In the situations described, the landlord’s intention is to make a capital investment, so the calculation of rent is often not based on market value but on the landlord’s investment in the property.
Some triple net agreements contain obligations for the tenant to pay full rent regardless of the condition of the premises. We’ve seen examples of agreements that state the tenant is still obliged to pay rent even though all or part of the premises became unusable during the lease period. There are even examples of agreements in which the tenant has committed to, at their own cost, reconstruct the building if it’s destroyed by fire, even paying rent for the time the building is being reconstructed.
The Rent Act
Chapter 12 of the Land Code (Jordabalken) is not adapted to these types of agreements since the Rent Act is, to a large extent, written with the perception that the landlord is an active and professional property owner, regarded as the stronger partner in the tenancy relationship.
Consequently, the Rent Act assumes it’s the landlord who carries the risks for the building and that the landlord is, to a great extent, responsible for maintenance of the building. The Rent Act also states that unless the rent amount is fixed, rent shall be calculated in accordance with an acceptable basis of calculation. Hence, in agreements with long validity periods, where all maintenance responsibility is incumbent on the tenant, it may be difficult for the tenant to calculate the rent in advance. It can therefore be disputed whether pure triple net agreements actually comply with the provisions of the Rent Act.
In our opinion, it’s time for a revision of the Rent Act, at least when it comes to commercial premises. This view is based on the major changes we’re seeing in the leasing market, attributable to the kind of agreements described here – and since there are clearly demands for more flexibility for tenants, with the current co-working trend perhaps the strongest indication of that need for greater flexibility.
It should also be noted that based on our experience, it’s still more common to see different kinds of triple net agreements where at least the maintenance is, to a degree, still divided between landlord and tenant. It remains unclear if the number of pure triple net arrangements is increasing.
“It’s time for a revision of the Rent Act, at least when it comes to commercial premises, based on the major changes we’re seeing in the leasing market.”