Making the switch to commercial property – how to avoid the risks

Daniel Stern explains the risks associated with leasing commercial property and how to best mitigate against them. 

Given that tax relief on buy-to-let mortgage interest payments for residential property will soon be slashed - phased in from April 2017 - while buy-to-let residential properties and second homes now incur an extra 3% stamp duty, various media reports suggest that as a result, many buy-to-let landlords are wondering whether they should shift their attention away from residential property to investing in commercial property.  

However, before you do make the switch, you need to be aware that commercial property has very real risks attached to it. Understanding those, and the steps you can take to reduce your exposure to them, must be key to your decision making.

Potential pitfalls

There are several issues that can arise when leasing commercial property, these include:

A tenant becoming insolvent and unable to pay the rent – this will lead to the lease being disclaimed resulting in an empty property and a business rates liability (after you have used up any relevant business rates relief). Not only will this leave a hole in your income it will also seriously impact upon the value of your investment.

A tenant vacating a unit (or you terminate the lease) and leaving it in serious disrepair – this can be a major issue if you do not know where the tenant has gone to (if it is an individual) or the tenant is an unprofitable company with little or no assets to recover your damages against.

A tenant sub-lets the premises or assigns it without your consent– this can present a number of complicated legal issues.

Increased risk of squatters, vandalism and theft – this is particularly true if the unit is left empty for a long period.

How to avoid issues arising

To ensure you minimise your risks as much as possible, you should:

Carry out detailed due diligence - carefully assess the ability of any proposed tenant to pay the rent and the other outgoings due under the lease. This can be done by considering their company accounts (these can be downloaded from Companies House), requesting additional current management accounts if possible and visiting any other premises they may be occupying to determine how busy they are. Overall, you need to get a good idea of the health of a tenant’s business before agreeing to lease a property to them.

Ask the tenant to provide guarantors – if it is a company tenant, ask for the directors to guarantee the company’s payment of the rent and the performance of the other covenants in the lease. You should also carry out due diligence on the ability of those directors to pay the rent and other outgoings due in the lease if the company defaults. In the event of the tenant leaving the property in disrepair and being unable to pay damages, you could then seek to recover them from the guarantors.

Draft comprehensive lease documents– this is your first line of defenceand will enable you to take the necessary steps to remedy any issues you have with the occupation and state of the premises.

Manage the property closely – keep a careful watch on who pays the rent and frequently visit the premises or appoint an agent to visit (provided the visits are in accordance with the terms of the lease) to determine who is in actual occupation and the current state of the property.

Keep the property well secured – this is the best way of preventing issues with squatters and vandalism or theft. If alease is still in existence, then this is the tenant’s responsibility and you should clearly communicate this to them. 

Daniel Stern is an associate solicitor specialising in property litigation in the dispute resolution team at Slater Heelis and is a recommended lawyer in the Legal 500 for property litigation.

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