How early break clauses may effect the market value of your property

How early break clauses may effect the market value of your property

With regard to rent valuation, decided cases demonstrate that it can be difficult to determine what impact certain clauses in leases will have when a lease is renewed. HHJ Mitchell, who gave judgment on Britel Fund Trustees Limited v B&Q plc, elected to give due regard to the nature of comparables.

 The implications were that the market value was significantly discounted. Peter Lewis, Patner at Rosling King, discusses the dangers to landlords of early break clauses in commercial leases.

Britel Fund Trustees Limited (“Britel”) was the landlord of a retail DIY warehouse of approximately 37,000 square foot in Tottenham Hale Retail Park, and had applied for the grant of a new tenancy under Part II of the Landlord and Tenant Act 1954 (the “1954 Act”). All the terms had been agreed with the tenant, B&Q plc (“B&Q”), save for the annual rent and interim rent. On the advice of an expert surveyor, Britel suggested an annual rent of £698,500 (or £18.90 per square foot) whereas B&Q, on the advice of its own valuer, argued for an annual rent of £281,000 (or £7.60 per square foot).

Of fundamental importance to the decision was the existence of an early mutual rolling break clause.

The parties agreed that there were two main issues:

- should allowance be made for a three month so called ‘rental holiday’?
- what is the open market rent for the lease with its break clause?

Applicable law

Section 34 of the 1954 Act stipulates that in default of an agreement between a tenant and landlord, a court may determine the rent payable under a tenancy granted by a lease, having regard to the terms of the tenancy, but disregarding matters including:

- any effect on rent of the fact that the tenant has or his predecessors in title have been in occupation of the premises;
- any goodwill attached to the premises by reason of the carrying on thereat of the business of the tenant; and
- any effect on rent of an improvement carried out by a person who was the tenant at the time the improvement was carried out, and who was not obliged to do so under an obligation owed to their immediate landlord.

Rent free period

In addressing whether allowance should be made for a three month ‘rental holiday’, HHJ Mitchell considered the conflicting decided cases. One school of thought appears to take a narrower approach, reluctant to import any factors not stipulated in the 1954 Act. On the other side, there is a greater willingness to give due regard to the comparables. The Court opted with the latter approach and one favoured in recent decisions by finding that a rent free period of three months would be granted and applied over the entire ten years of the lease. Further to this, the Court added that when considering comparables, like must be compared with like.

Open market rent

Complications arose due to the presence in the new lease of the early break clause.  The Court agreed with B&Q’s argument that the market rent should be determined on the basis that the hypothetical tenant would be a discounter (i.e. a tenant who only requires a quick fit out of the premises and trades at a discount rate) rather than as a DIY retailer.

This is because the mutual rolling break clause, which drew considerable attention in the valuation, meant that Britel could exercise the break when B&Q would have been trading for less than 2.5 years, when the time required to fit out the premises is considered. Indeed, both experts contended that no DIY retailer would have taken a lease with this early break clause. The Court found that the market rent payable by a discounter was £466,940 per annum whereas it would have been £603,100 for a DIY retailer. HHJ Mitchell made this valuation without the benefit of comparable evidence owing to the lateness of this concession at the hearing.

Having established that the hypothetical tenant would be a discounter, it was necessary to determine the discount to reflect the early break clause. The Court held that the discount for a DIY retailer would be 25 per cent whereas it would be 20 per cent for a discounter. After applying the discount, the valuation was found by the Court to be £373,700 per annum. This represents a striking difference to the £603,100 per annum valuation (assuming the lease did not have any break clause) HHJ Mitchell would have found for the landlord, had the early break clause not rendered the lease unsuitable for any retailers other than discounters.

Post-Britel Fund Trustees Limited lessons

There are no indications that the decision will be appealed. Landlords should consequently think carefully about inserting an early break clause into commercial leases and be mindful of who the hypothetical tenant is. It was illustrated in this case that both factors can have a pronounced impact on market value that is difficult to ignore. The Court firstly discounted the market value owing to the early break clause. The value was further reduced when the Court conceded to the opinion of the experts, who stated that no DIY retailers would accept the early break clause, meaning that the hypothetical tenant was not a “willing lessoree.”

The case also illustrates that a court may adjust the market rent to take into account a rent free period and that comparable evidence should be carefully reviewed to ensure the comparisons are on a like-for-like basis and appropriate adjustments made.

Join our mailing list:

Leave a comment

Our Next Event

Specialist Lending Roadshow June 2017

Specialist Lending Roadshow June 2017

Crewe - 20/06/2017

Northampton - 21/06/2017

Chingford - 22/06/2017

Brighton - 23/06/2017

Register now

Latest Comments

Oliver Conway
Oliver Conway 18 May 2017

Making a neat inventory is a good idea, but if the seller is not willing to provide it, can the buyer demand it?

view article
Bertrand 17 May 2017

First step to nationalisation of the private rented sector IMHO. Nanny state poking their noses into things yet again. I object, as a decent landlord, sometimes having to deal with some pretty awful tenants,...

view article
Izzy 16 May 2017

This is such a great a post. I love the detail you've gone into. It's a very useful article for helping those who are looking at deciding which sector they would like to go into! When I first started investing...

view article
paul burnham
paul burnham 30 Apr 2017

Jeremy Corbyn's pledge that a Labour government would build 500,000 new council houses must electrify the general election campaign. Reliance on markets and the profit motive has brought huge housing-related...

view article
CommercialTrust 28 Apr 2017

Sadiq Khan?s announcement of an online database of landlords and letting agents who have been convicted of housing offences, appears on face value to be a variation of the already implemented Database

view article
warren 26 Apr 2017

You're very welcome Mary! Glad you enjoyed them :)

view article
Mary Ward
Mary Ward 26 Apr 2017

Thank you for the wonderful ideas. First impressions can make or break a deal. It's sadly that many homeowners drop the kerb to create an off-street parking space.

view article
Tony Gimple
Tony Gimple 14 Apr 2017

I'm not at all surprised that so many landlords are still confused about what the tax changes really mean and how it will affect them. In particular, the blind rush to incorporation is leaving landlords...

view article
MH 13 Apr 2017

You are right that the bank holidays are going to be spoiled in looking for the properties. But people who want to sell their property and looking for the better relocation, they can get benefits of this...

view article
bnellyb 08 Apr 2017

There will be an exodus of private landlords over the next 5 years as tax changes take effect, private landlords provide an important service to the rental market, why do housing associations and councils...

view article
Fred Cassman
Fred Cassman 07 Apr 2017

"Make it look like you are at home": often people forget this and share on facebook their location!

view article
jared townsend
jared townsend 05 Apr 2017

It'll be interesting to see how & if the Government's asset sale regarding mortgages helps

view article

Related stories

More articles from Special Features

Specialist Lending Roadshow June 2017

20th-23rd June

4 days
7 specialists
4 locations
Free to attend

Click here to register now