If you’re looking to move into commercial premises, either as part of a business purchase or because you are starting up a new business, you may be confused about the differences between, and potential implications of, buying or renting (leasing) commercial property.
There are a number of differences between freehold and leasehold title but one key distinction:
As owner of a freehold commercial property you have exclusive ownership of that property. It is your asset and you can choose whether, and when, to sell it and move out at your own discretion.
A leasehold title, on the other hand, means you will not own the property but just be given exclusive possession of the premises for a fixed or periodic term as a tenant. Whether or not you are able to assign (sell) your lease to a third party, or to move out of the property before the end of the fixed term, will depend on the terms of the lease and the consent of your landlord.
Taking into account this distinction, you may think that buying the freehold to a commercial property is always the preferred option for any business, but that’s not necessarily the case. Depending on your circumstances, a commercial lease may actually be more suitable.
Pros and cons of buying Freehold business premises
The pros of buying your commercial property are:
- You will be the exclusive owner of that property until such time as you choose to sell it, giving you long term security for your business;
- The property itself is likely (although not guaranteed) to appreciate in value as an asset, irrespective of the success of your business;
- Commercial mortgage payments on the property are likely to be lower in the long term than paying monthly rent, which may be subject to sudden and significant increases, and interest payments on commercial mortgages are tax deductible;
- Subject to obtaining any necessary planning permissions from the local authority, you will have the right to extend or alter the property as your business grows;
- If the terms of your commercial mortgage allow it, you may be able to sub-let part of your premises to generate an additional income stream.
There are, however, some disadvantages to buying freehold business premises which you need to take into consideration:
- The purchase will tie up a big chunk of capital that you could otherwise use to invest in the business. Lenders typically require a deposit of between 20% and 30% of the property value as a deposit;
- You will be responsible for all maintenance and repair of the premises;
- It can be a headache to relocate if your business needs to expand and you don’t have the space or permission to increase your current property footprint. You either have to sell up, which can be a protracted affair, or try and find a suitable tenant;
- There is a possibility that the value of your asset will go down – and, if it doesn’t, you will be liable to Capital Gains Tax on the sale of the property for a profit.
Pros and cons of renting Leasehold Commercial Property
There are a number of potential advantages to leasing commercial property rather than buying:
- You will have exclusive possession of the property for a fixed period of time;
- Part II of the Landlord & Tenant Act 1954 may give you the right to extend your lease at the end of the term if you request a renewal on the same terms (but you will need to check that your lease does not expressly exclude this legislation);
- Short term leases offer greater flexibility to move to alternative premises in line with the changing circumstances and needs of your business. Longer term leases may contain a break clause that give you this same opportunity;
- It’s usual for the landlord to pay for buildings insurance and to take on some responsibility for structural repair and maintenance of the premises;
- Less capital is required up front to acquire the premises, giving you more options to invest in the business. While tenants are usually required to pay a rent deposit, this sum will be significantly less than the deposit required for a mortgage and the deposit is refundable if none of the terms of the lease are breached.
- It’s common for leases to contain rent review provisions which means your monthly rent may be subject to a periodic price hike;
- If you don’t carefully review the lease provisions before you take the property on, you may find that you become trapped in a situation where the premises are no longer suited to your business requirements but, legally, you have no way to get out of the lease. This is a common problem for tenants and made particularly difficult if they are also struggling to make rental payments and have no permission to sub-let;
- You won’t be able to alter the premises to accommodate your changing business needs in any way without the landlord’s permission, which may not be forthcoming;
- You will be required to put the premises back to their original state when you leave, which could be costly;
- If you assign the lease (with the landlord’s permission) you will be under an obligation to guarantee that the new incoming tenant will pay the rent;
- At the end of your tenure, you will have no asset to show for your investment.
What if I’m offered a Licence to Occupy or Short Term Tenancy?
If you’re just looking for a short term tenancy of up to a year, then you may be offered a Licence to Occupy. This differs from a lease in the following ways:
- It will only give you permission to occupy the premises (or a particular area within the premises) for a particular purpose – there is no exclusive possession of any part of the property for any period of time;
- Short term tenancy: typically, a licensee will only be granted the right to occupy the premises for a period of between 6 and 12 months (although the licence may automatically continue in force);
- Either party may terminate the licence agreement by giving the other a short period of notice;
- The licensor may, at any time, ask the licensee to move to a different area of the building than that originally used;
- The licensor may enter the property at any time;
- The licensee may have responsibility for maintaining the interior of the property.
It’s not difficult to see that such an arrangement could cause significant problems for a growing business, offering very little security as to the particular area of a premises rented, let alone the length of the tenancy itself.
Nevertheless, a licence to occupy suits some business owners looking for the flexibility of a short-term premises solution for a particular phase or project. A licence is also sometimes used to give a business buyer quick access to the business premises whilst the terms of the main lease are being negotiated.
It’s worth bearing in mind that what purports to be a licence or a short-term tenancy may, in the event of a dispute, be deemed by the Courts to be a lease. This is because the Courts will look at the substance of the agreement and the intent of the parties, not the label given to the legal document.
In such a scenario there would, of course, be wider implications for both the landlord and the tenant as the Landlord & Tenant Act 1954 may apply to extend the term of the arrangement, which a landlord may not want to happen.
And what about a Tenancy at Will?
A Tenancy at Will is a personal arrangement which either the landlord or tenant may bring to an end at any time, without the need to give any notice.
Whilst a Tenancy at Will does confer exclusive possession to the tenant, it does not give the tenant any interest in the premises. Similarly to a Licence, any anomalies in the drafting of the Tenancy may have the effect of it being regarded, in law, as a lease.
Avoid costly mistakes! Make an informed decision about your business premises
So, whether or not it’s best to buy or rent commercial property – or, indeed, to accept a Licence to Occupy or Tenancy at Will – will depend entirely on your personal circumstances and the nature and stage at which your business is at.
This article highlights just some of the key differences and potential pitfalls. It doesn’t touch on widespread variations in the drafting of what can be lengthy and complex legal documents. Nor does it go into the finer detail of tax implications or, for that matter, the best way to legally structure your business so as to avoid tax liabilities.
The message is simple: if you’re contemplating buying or renting commercial property from which to operate your business, seek professional advice and support, preferably from a solicitor who has expertise both in business law and commercial property law.
Sadly, far too many business owners and entrepreneurs find themselves in protracted and costly disputes relating to the occupation or use of their business premises – disputes which could have been avoided if early advice had been taken.
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