Entering the UK retail market

Property is generally made available to retailers in the UK on a leasehold basis.

Demand for space in the top retail shopping centres and out-of-town retail parks is high, although the economic climate in the UK in the last two years has caused tenant insolvencies which have left plenty of available properties in less-favoured high street locations. The slowdown in property development, and the lack of new properties being introduced to the market since the change in economic conditions, have led many to speculate that this will heighten demand and will operate to increase rents charged in the primary retail locations.

Typical terms

The opportunity to acquire property might come in the form of a new letting offered by a landlord, or from an existing tenant seeking to relocate (and therefore seeking to transfer its existing lease).

In either case, if the prospective tenant is a start-up company or is based outside the UK, landlords are likely to require additional financial security for payment of the rent. This will probably take the form of a deposit equal to six or 12 months’ rent. This deposit reflects the increased difficulty of enforcing payment and other lease obligations should the landlord need to seek to enforce legal action outside the UK.

In the case of the transfer of an existing lease, there is little opportunity to renegotiate the lease terms which are already in place. The landlord’s consent to a lease transfer will be required. Although the landlord is usually not legally entitled unreasonably to withhold its consent to a proposed transfer, the obtaining of consent and the need to document that consent is far from being a formality, and has the potential to delay completion of a transaction by a number of weeks.

If a new lease is being taken, the tenant’s ability to influence its terms will depend on a number of different factors.

The UK property market has a reputation for inflexibility in the nature of the lease terms available. The previous UK government threatened for years to introduce new law to force the market to adopt more flexibility in lease terms. The threatened legislation never materialized, however, and only limited progress towards greater flexibility has been made.

A code of practice (the Commercial Lease Code) has recently been reissued. While compliance remains voluntary, the code provides excellent, detailed guidance for any new entrant to the UK market on the issues that need to be considered.

Rent, term and service charges

Usually the tenant will pay a basic rent. Traditionally this has been paid quarterly in advance, although in recent years landlords are increasingly agreeing to rent being paid monthly. In major retail locations it is also common for tenants to pay a base rent which is set lower than the market level, plus an additional rent based upon a calculation of turnover. The calculation of the “turnover rent” will require the tenant to disclose trading information to the landlord on a regular basis.

It is usual for rent to be reviewed every five years, on an upwards basis only. Accordingly if the market falls and the property becomes more expensive than current market rent, the tenant will bear the consequences and will still pay the originally agreed rent.

A tenant leasing new property will commonly want to take a 10 or a 15-year lease, simply in order to be guaranteed a return on the amount it invests in initial fit-out costs. This aside, tenants are increasingly seeking to agree shorter leases (for example a five or 10-year term with an option for early termination after five years), in an effort to increase flexibility and protect themselves against the possibility of paying a rent that is higher than the market rent later in the lease.

The tenant will be expected to assume responsibility for the repair and insurance of the property, although in shopping centres the tenant will be required to look after the interior of the centre, and the landlord will assume responsibility for the structure and common parts of the building, and for insurance. The landlord will then to seek to recharge costs shared between the tenants through a service charge.

Service charges have been a source of contention in recent times, with tenants in some retail locations expressing concerns that service charge costs are too high and do not represent good value.

One of the responses to these concerns has been an updated code of practice issued by the Royal Institution of Chartered Surveyors (Service Charges in Commercial Property: RICS Code of Conduct) which contains information about “best practice” in relation to how service charge accounts should be operated. An incoming retail tenant should satisfy itself with the levels of service charge charged to tenants in previous years, and take advice on the potential financial exposure.

Other costs and considerations

With regard to other potential costs, stamp duty land tax, which is a “one off” property tax, is payable by any commercial tenant following the execution of a lease agreement. This is calculated upon the level of rent and the length of the lease.

Business rates, which are a regular property tax based upon occupation, are also payable to the local authority in the area in which the property is situated; the level of business rates is reviewed every five years. A new tenant also needs to be mindful of various property and occupation-related regulations which need to be considered.

Further information on UK retail property can be obtained on line from the British Retail Consortium website at www.brc.org.uk and from the Eversheds international real estate directory at the following address: http://www.eversheds.com/uk/home/services/real_estate_portfolio_management/real-estate-directory.page

Paul Moorcroft is a partner at Eversheds