Middle East | Publication | March 2021
As interest by international companies in taking office space returns in the UAE, we have taken the opportunity to look at some of the key tenant demands that we have come across more regularly in recent times and the implications of accepting them for landlords. Below is our “Top Ten Tenant Requests” with a note on the likely issues for landlords of accepting them (and a brief summary of some of the legal consequences associated with them).
| Tenant’s request |
Landlord’s response |
Legal considerations |
|---|---|---|
|
Lower Rent A lower rent (either initially or for the term of the lease) is a fairly basic way of making premises more attractive to a tenant. Typically negotiations start with rent; but there are many more ways of creating long term value for the tenant. |
Agreeing to a lower rent can have building valuation issues (as the valuation is often a product of the rent payable and expected yield for the asset class). There may also be implications for landlords with financing arrangements – such arrangements can contain covenants against agreeing rents below a particular level. |
A reduced rent ought to be structured carefully so as not to fall foul of any rent capping legislation on renewal or financing covenants (in which case incentives such as rent free considered below may be appropriate). |
|
Cap on Service Charges Tenants of premises in a multi-unit building will typically seek a service charge cap (either initially or for the term of the lease). Tenants will typically wish to ensure that service provision is not impacted by any reduction to service charge costs. |
A service charge ought to cover the cost to the landlord of providing services to the premises. A cap can create a shortfall which the landlord will typically have to fund from its own resources (as opposed to using the funds collected from other tenants in the building). |
Not all service chare regimes pass through the actual cost incurred by the landlord for providing the services. Some instead just allocate an amount to service provision. Both parties need to understand the basis of the service charge regime before seeking to negotiate any cap / reduction. If the cost is expressed to be a pass-through of costs incurred, landlords might expect the lease to include a tenant right to audit the costs incurred by the landlord and require transparency of costs. |
|
Early break option An option for the tenant to end the lease early on unilateral notice. Alternatively a shorter lease with a unilateral option to renew. This will give the tenant more flexibility should its business needs change during the course of the tenancy. |
A shorter lease or a lease with a tenant-only option to break will have an impact on the value of the building. Landlords should bear in mind that tenants will often only choose to move premises where a significant saving can be made, given the other costs of relocating (such as fit-out and general business interruption). |
Careful drafting is required to ensure that the break option works properly and the parties understand their responsibilities on termination (i.e. reinstatement requirements). There can also be lease registration issues / costs for differing lengths of terms depending on the jurisdiction which need to be considered. |
|
Rights to assign or sublet An option for the tenant to sublet the premises or to assign the lease to a third party will allow a tenant to wholly or partially divest itself of financial risk where it is able to find an alternative occupier for the premises. |
The risk associated with agreeing subletting / assignment can be reduced where the landlord is entitled to request of the incoming tenant / sub-tenant additional financial security such as a guarantee / rent deposit. |
The landlord and tenant should be careful to ensure that what they have agreed is carefully documented in the lease documentation. Anything too generic creates the risk of not having the intended outcome for one of the parties at the relevant time. |
|
Relaxed reinstatement obligations An option for the tenant to leave its fit-out in place at the end of the term of the lease. Tenants with high quality generic fit out requirements may be in a stronger position to make such a request as it is likely that their fit out could enable the landlord to re-let more easily. |
The risk associated with this for the landlord is that an incoming tenant might not want the outgoing tenant’s fit-out (with the cost of reinstatement then falling on the landlord with the additional loss of revenue for the period of reinstatement). |
The parties should ensure that the repairing obligation (a separate obligation to the alteration obligation) in the lease takes into account any waiver of the requirement to reinstate by the tenant to avoid the landlord being left with an unusable fit-out. |
|
Repairing obligations An option for the tenant to leave the premises in the condition it was at the start of the lease (fair wear excepted) is a fairly common request by tenants in the region. |
Landlords should be mindful that a repairing obligation such as this (as with many of the other requests mentioned in this note) would characterise the lease as something short of “institutional” which could have an impact on the ability to finance or sell the building. |
The parties need to ensure that they have documented the state of the premises at the commencement of the lease. This is usually done by the preparation of a detailed “schedule of condition” by the landlord which would be appended to the lease. If this is not done, then evidentially it becomes difficult to understand the tenant’s repairing obligation and whether there has been compliance. |
|
Expansion / contraction space The right of first refusal over neighbouring space or the right to hand back part of the premises could give a tenant increased operational flexibility. As can the availability of shared spaces (such as conference rooms / data centres / break out spaces). |
If the landlord has premises that can accommodate such flexibility then there is little downside in offering these; as long as it is done clearly and the landlord gives consideration to the long term impact of making such concessions. The landlord and tenant need to be very clear about the expectations. |
If neighbouring space is to be offered to the tenant; issues such as how much notice is needed / what rent should be payable / what flexibility should be in the neighbouring lease all come into question. If the landlord is simply offering use of shared facilities, again the parties need to be clear about expectations, the cost of use of such facilities and whether they will be available for the life of the lease. |
|
COVID-friendly clauses A right to a suspension of rent in the event of a pandemic (such as COVID-19). The impact of COVID meant many tenants were unable to operate from their leased premises and had to ask landlords for concessions at the relevant time (rather than being entitled to them under their leases) or rely on regulators to impose concessions. |
This is likely to be a more regular request from tenants who are feeling the impact of paying rents for premises that they have not been able to use. Whether it becomes accepted in the market will depend on how quickly the market recovers. |
If such a clause is to be agreed, it needs to be very carefully drafted to ensure it only covers what the parties intend: for example full government lockdown or just recommendations to work from home |
|
Incentives: Contribution to fit out A contribution by the landlord to the tenant’s cost of fit out. This might appear as having the same economic impact on the tenant as a reduced rent; however, from an accounting perspective / tax perspective there could be advantages to the landlord’s contribution to be structured in this way for both parties. |
Structuring a financial concession as a fit-out contribution could be useful from the perspective of keeping headline rents (also known as quoted rents) high (which might have a benefit to the landlord in the event of rent reviews taking place elsewhere in the building). |
Careful consideration of the accounting and tax treatment of any such contribution should be undertaken before agreeing to characterise an incentive as a fit-out contribution. |
|
Incentives: Rent-free A contribution by way of rent-free period, as with a fit-out contribution could be seen just as another way of achieving the same economic impact for the landlord and tenant. Structuring in this way gives the tenant the benefit of lower outgoings when its business is establishing itself / it is undergoing higher costs |
As with a fit-out contribution a rent-free can assist in keeping headline rents intact. Landlords should consider rent-free requests in conjunction with tenant break rights (and consider claw back provisions in such circumstances if an early break is offered). |
The lease should be drafted so as to ensure any renewal lease does not also incorporate a rent-free period (unless that is what is subsequently agreed). |
Of course, this is not an exhaustive list of the shopping lists that tenants have when seeking to take premises; but it does serve to identify that landlords are increasingly being asked for additional flexibility. If a landlord is willing to be flexible, there are plenty of ways to add value (and some pitfalls to avoid). If you would like to discuss any of these in more detail, please do get in touch.
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