Securing the right lease for your dental practice: key considerations when taking on leasehold premises
The premises out of which a dental practice is run are one of the most important elements of a dental practice sale/purchase. It is important that time and care is taken to ensure that the terms on which the practice occupies the premises are appropriate for the continued requirements of the business.
There are three common scenarios that exist in the
acquisition of a dental practice:
- the seller owns the freehold of the premises and grants a lease to the buyer;
- the seller has an existing lease of the premises and assigns its interest to the buyer;
- the buyer takes a new lease from a third-party landlord.
All the above scenarios provide opportunity for negotiation of the lease terms and it is important that a buyer considers carefully whether the terms are appropriate for its plans for the business, and also ensures that it is not opening itself up to undesired liabilities and/or obligations in respect of the premises. We set out below some of the main terms of a lease and what a buyer needs to consider before it commits to taking on or entering into a lease arrangement.
A buyer will want to ensure that it can occupy the premises for a considerable period. Ordinarily, a lease term of at least 15 years is sought on a purchase of a dental practice. Consideration needs to be given to the funding arrangements of the buyer. The “starting position” for an institutional high street lender is often that they require the lease to be in excess of 15 years, however, there is normally flexibility where dealing with dental practices (where the value sits within the business itself). Where there is a lender involved, a buyer should look to engage with the lender early in the process, to ensure that the lease arrangements meet its requirements.
Whilst ensuring that the term of a lease is adequate for a buyer’s business plans, equally, a buyer may wish to look at ensuring that it has the flexibility to relocate in the future (whether that may be in a situation where more attractive premises become available, or to mitigate against future rent increases) or to protect against unforeseen circumstances.
Conversely, a lease may include break rights in favour of a landlord, to allow the landlord to take back the premises. Break rights can take the form of specific dates e.g. the 5th and 10th anniversaries or arise as a result of a trigger event, e.g. the tenant’s NHS contract being terminated.
When dealing with a new lease arrangement, break rights are very much a commercial negotiation between the parties. The buyer’s desire for break rights to ensure flexibility in the longer term may come at a price, typically, in the form of paying a higher headline rent. Incorporating break rights into an existing lease is rarer, as it does not make commercial sense for a landlord to accept such a concession unless they are being offered something in return (again, an increase in the passing rent being the obvious incentive that a buyer can offer, or a premium being payable if the break right is actually exercised in the future).
It is always prudent to ensure that the terms of a break right are reviewed by the buyer’s solicitors. There are many instances where break rights have been incapable of being exercised by a tenant due to the way that they have been drafted (and the preconditions to be satisfied before the break can be exercised).
Rent and rent reviews
The headline rent payable under a lease will be readily apparent to a buyer on undertaking its due diligence and taken into consideration in reaching a proposed purchase price for the dental practice. A buyer should agree at the outset with a landlord, the basis of any rent reviews during the term of the lease, together with the frequency of the reviews. Where the buyer is taking over an existing lease, it should ensure that its solicitors have reviewed the rent review provisions of the lease to check that there are no unexpected “surprises”.
Most leases will include rent reviews that are either carried out on an upwards only open market basis or are index linked to the Retail Prices Index.
Both methods of review have their advantages for a buyer. An open market rent review will likely lead to low or minimal rent increases in a market where rental values are depressed (i.e. during an economic downturn), whilst an RPI review can provide a buyer with some level of assurance as to the likely level of rent increases throughout the term (additional security can be obtained by “capping” the potential percentage increase from one review to another).
Conversely, where the demand for commercial premises increases and/or availability of premises is limited, an open market rent review can lead to more dramatic rental uplifts. A buyer also needs to take care to check that the initial rent is not artificially inflated e.g. to reflect works the tenant has undertaken, as that could lead to an unexpected uplift when the rent is next reviewed. The main disadvantage of an RPI rent review is that the index is unlikely to decrease and therefore the rent is always going to go up over the term, irrespective of the wider state of the commercial property market.
The single greatest cost or liability to a tenant under a lease (excluding the rent) is the cost of complying with the repairing obligations under the lease, including any obligations placed on a tenant at the end of the term. Where a lease includes a “full repairing obligation” on the tenant, the tenant will be in a position where it must attend to all wants of repair, regardless of whether they were pre-existing when the lease was granted.
A buyer should always ensure that it carries out a survey to identify any items of disrepair; even if the buyer will not be under a direct obligation to the landlord to deal with such items; it could be that they have a fundamental impact on the operation of the business, e.g. a serious leak in the roof.
Where a buyer is entering into a new lease and there are items of disrepair, the buyer would be prudent to look to agree with the landlord that either i) the landlord carries out repairs before the buyer becomes responsible for the premises or ii) the buyer’s repairing obligations are limited by reference to a “schedule of condition” (which normally takes the form of a series of photograph evidencing the existing disrepair, with the tenant having no obligation to attend to such items either during the term or at the point at which the premises are handed back to the landlord).
Where a buyer is taking over an existing lease, it will need to ensure that it understands what its obligations will be to the landlord and the likely cost of complying with the same. In some instances, a buyer may take over a lease on the basis that the seller either carries out certain works before completion, or there is a deduction in the purchase price of the practice to reflect future outlay by the buyer to attend to the items of disrepair.
Where premises form part of a larger building, the lease arrangements will ordinarily include a service charge arrangement with the landlord. The landlord will be under an obligation to provide certain services in return for the tenant paying a proportion of the overall costs.
The services to be provided by a landlord will depend on the nature of the building, but will typically include things such as the landlord repairing the structural and common parts of the building, ensuring that any common parts are kept clean, maintaining any shared service media etc.
A buyer should look to ensure that the services to be provided by a landlord are adequate for the continued running of the business from the premises and look to get a firm understanding of the likely service charge payable. Whilst information as to the historical service charge/service charge for the next accounting year should be readily available from the landlord, care should be taken to fully understand the terms of the lease and exactly what can be charged back to the tenant.
Service charge arrangements are one of the main areas of dispute between landlords and tenants and it is not uncommon to discover lease terms that offer little by way of “safeguards” to tenants and/or allow the landlord to recover costs that a tenant would not envisage as being recoverable.