Leases in the retail sector: Heads of terms for retail leases

Before lease negotiations even begin, the parties’ agents will generally negotiate heads of terms, setting the foundation for the lease. Retail tenants should involve solicitors early in this stage to review and comment on the draft heads of terms. While heads of terms are usually stated to be "subject to contract," departing from these terms later on can cause complications.

The Royal Institution of Chartered Surveyors (RICS) introduced the 2020 Code for Leasing Business Premises, which aims to improve the quality and fairness of lease negotiations. Although the Code is mandatory for RICS members, it serves as best practice for all landlords, and following it can lead to more efficient lease drafting and smoother negotiations.

The key issues when negotiating heads of terms are outlined below. These elements are crucial in ensuring that the lease is not only balanced but also tailored to the specific needs of the parties:

• Premises identity and extent: Clearly defining the premises is critical, particularly if the space includes shared areas such as loading bays, car parks, or communal spaces. Retail tenants should ensure that their lease accurately reflects the space they intend to occupy.
• Special rights: Retailers often require special rights, such as parking or access to data and telecom services. These rights should be explicitly outlined in the heads of terms to avoid ambiguity.
• Term length and renewal/break rights: The length of the lease and options for renewal or break rights are particularly important for retailers, who may need flexibility depending on market conditions and business growth. A well-negotiated break clause can allow retailers to exit the lease early if needed.
• Rent and rent reviews: Rent is one of the most critical issues for retailers, particularly in high-street or premium locations. Retailers should be mindful of the rent amount and review frequency. Rent reviews should be carefully negotiated to avoid steep increases. Additionally, having a rent-free period or other incentives can provide valuable financial relief at the start of the lease.
• Service charges and insurance: Retail tenants are often liable for service charges that cover common area maintenance, management fees, and sometimes even marketing costs. These charges can add up, so it’s important for retailers to understand exactly what they will be responsible for. Similarly, insurance premiums should be clearly allocated to avoid unexpected costs.
• Alterations and fit-out: Retailers often need to make alterations to the premises to suit their specific business needs (e.g., fitting out a store or installing signage). The lease should clearly state the retailer’s rights to make alterations and any reinstatement obligations at the end of the lease. Restrictions on alterations could significantly impact a retailer’s ability to operate efficiently.
• Repairing obligations: Retail tenants should be cautious about agreeing to full repairing obligations, especially in older buildings. These obligations can be a significant financial burden if the premises require extensive maintenance or refurbishment. Retailers should consider whether it would be appropriate to negotiate a cap on their responsibility for repairs.
• Use clause: The permitted use clause is vital for retailers, as it defines what activities can be conducted in the premises. Retailers should ensure that the clause is flexible enough to accommodate potential changes in their business model, such as the introduction of new product lines or services.
• Assignment and subletting: Retailers may wish to assign the lease or sublet part of the space if their business needs change. It’s important for retailers to negotiate favourable terms regarding assignment and subletting rights to maintain flexibility. In addition retailers should consider whether they intend to grant concessions at the Property and if so they should consider trying to agree that this can be carried out without landlord consent.
• VAT on rent: Retail tenants should clarify whether the landlord intends to charge VAT on the rent. This can impact the overall cost of the lease, particularly for retailers who may not be able to reclaim VAT.

The RICS code and retail leases

While the 2020 Code is not legally binding on landlords who are not members of RICS, adopting the provisions can streamline negotiations and ensure fairness. For retailers, following the Code's best practices can help prevent disputes and ensure that the lease reflects the operational needs of their business. A clear, balanced lease is not only more manageable but can also reduce legal costs by avoiding extensive negotiations later in the process.
In the upcoming articles, we will explore each of the above lease provisions in detail, with a focus on the unique concerns and needs of retail tenants. From rent reviews to altering the premises, we will provide insights into how retailers can negotiate terms that support the long-term success and growth of their business.

For more information or advice, please contact Steve Faragher in our Real Estate team