News & Insights

What is a lease re-gear?

Rebecca Staunton, a solicitor in our Real Estate team, summarises the benefits of a lease ‘re-gear’, which is popular following the COVID-19 pandemic.

During the coronavirus-induced economic slowdown, landlords and tenants may each be interested in possibilities to reduce risk or cost.  For landlords, such risk-mitigation may involve trying to retain existing tenants whose leases are about to expire, while for tenants the strategy may be to keep rental outgoings low while trading income is down.  It is in these circumstances that a lease re-gear may prove beneficial to both parties.

Where does the jargon term ‘re-gear’ come from?

Principally from the debt sector, where the trade-off is generally between interest rate and loan term length.  In the context of real estate, a lease re-gear is a renegotiation and alteration to the terms of an existing lease in a way which is mutually beneficial or satisfactory both to the landlord and to the tenant.

What might a ‘re-gear’ involve?

A lease re-gear usually involves a trade-off: for example, a landlord may give a rent-free period or permit a lower rent to be paid for a period of time if the tenant, in return, commits to a longer term of years; or the tenant may “sell” a break option in return for a rent reduction or a cash incentive.  In either case the landlord is reducing the risk of having a vacant property, on a break or after the lease would have expired, while the tenant is benefitting from a lower rent.

The bargain is that tenant gets an immediate cashflow benefit, and the landlord gets a lease product which ultimately grosses more income over its term and/or under valuation principles gives a higher capital value, which can be used to justify higher bank borrowing or be realised on a sale. As a further incentive to keep tenants in the space is to negotiate a reduced service charge (especially if the tenant is not able to use the space and therefore the amenities and services) again assisting with the tenant’s cash flow.

In this market, landlords who want to avoid, or who are unable to justify, giving away concessions to struggling tenants (perhaps because they are under pressure from their own banks) may be persuaded if there is something in it for them in the longer term.  If a re-gear defends or boosts capital values then banks are more likely to agree to the change in lease terms, when a simple waiver of rent may be a breach of the landlord’s banking covenants.  One can see that a cash-strapped tenant with a fundamentally sound business if it weren’t for the exceptional event of lockdown is worth keeping.  So, if a tenant believes that it is able in the long term to carry on a successful trade from the premises, and if the landlord has no plans requiring the premises to be vacated, a lease re-gear becomes, for both parties, a commercially sensible option.

The parties should open a channel of communications to establish whether there are any particular factors which might affect their decision to re-gear the lease. In some cases it could be terms of the lease, such as options to break or rent free periods as mentioned above. In other cases this could be the physical aspects of the property, such as air conditioning units, common areas (like bathrooms or kitchens), heating systems, decorations etc. If tenants are happier with the standard of their amenities, especially if they are responsible for their upkeep under a fully repairing lease, they may be more willing to extend their lease term. The landlord should consider whether the expenditure in the short term will be worth the certainty of rent for a longer period.

In the context of the rising current “working from home” culture and need for social distancing, a tenant could also have a need for smaller (for less bodies) or larger (to allow spreading-out) space than currently demised under their lease. Provisions for alienation in the lease can sometimes be restrictive and may not allow the tenant flexibility as to do what to do with the space they are paying for. The landlord may not want to negotiate these restrictions as they protect the landlord’s investment, instead choosing to grant a new lease of a different demise and keeping their control of the identity and occupation-status of the occupants.

In summary, the principal lease terms which could be amended are:

  • the rent – rent holidays, rent deferment, or monthly rather than quarterly payments,
  • break clauses – removing them, or converting rent concessions into an exit payment if not removed,
  • rent review provisions,
  • the term (i.e. duration) of the lease,
  • maintenance obligations,
  • restrictions on assigning, sub-letting, or changes of use; and
  • the tenant’s demise.

Even on a ‘re-granted’ lease, for leases of a comparatively low rent the availability of ‘overlap relief’ may mean that no or little Stamp Duty Land Tax would be payable.

How to do it?

Re-gears are usually relatively simple legal arrangements by way of a Deed of Variation.  Some agreed changes are straightforward but some (especially if the physical premises or the duration of the lease is extended) effect a ‘surrender and re-grant’ of the lease.  Getting legal advice is important (whether you are landlord or tenant) to ensure that such a situation is identified correctly and its consequences are understood and dealt with appropriately: this can be to do with losing guarantors, accidentally conferring security of tenure where there was none, requiring third-party (especially bank) consents, triggering liability to Stamp Duty Land Tax, and a need for refreshed Land Registration.  A Deed of Variation is often the most suitable method for minor changes. Furthermore, both parties would benefit from surveyors’ advice on the value of the lease and the property, especially if negotiating terms regarding maintenance and alterations.

Wider ranging amendments, (say) to maintenance obligations or rent review terms, may be best set out in a whole new lease document rather than a long and complex variation deed.

If you think that your leasehold premises or let investment could benefit from a lease re-gear, you should take expert surveyor advice, and do contact our Real Estate team.