EM&F Guides
Freehold or Leasehold
We get many enquiries from people who wish to buy a business yet are unfamiliar with the advantages and disadvantages of the two types of tenure, or who resolutely set their sights on buying Freehold - because it is what they are familiar with - yet because of their limited capital are unable to find anything they are capable of buying. Here then are a few notes which we hope will answer some of your questions.
FREEHOLD
Most people are familiar with Freehold because they have owned a Freehold house. It means, of course, that you own both the land and the building that stands upon it and are at liberty to repair it (or not!) or alter it (subject to the permission of the local Council). Very occasionally there are 'covenants' within the deeds which may place restrictions upon what one may sell in the shop or indeed what may be built on the land. The main disadvantage is of course the cost of buying both a suitable Freehold property and a worthwhile business. Many people would argue that it is preferable to buy Freehold if you can afford to, but there is also a good argument that says that, even if you have ample funds to buy a Freehold business, you would be better off investing all those funds into a better Leasehold business than to tie a substantial part of your capital in the Freehold of the property.
LEASEHOLD
There are various types of leases but the one, which typically occurs in dealing with businesses these days, is the tenancy lease. These are sometimes referred to as ‘short leases' and usually start off with terms of 21 years or less (although there could be any period at all left of the lease at the time the business is being sold). Typically a ‘new' lease granted these days would be for about 15 years. With a lease you do not 'own' the property (either the building or the land) but instead you have the right to occupy it during the period of the lease, subject to your paying the agreed 'rent' to the Landlord and to your observing the conditions within the lease, and there may too be some restrictions as to what you may sell in the shop (or what you may not sell). It is commonplace these days for leases to be 'full repairing and insuring' (F.R.I.) which means that the tenant must keep all the property in good repair and pay the insurance premiums, however, whereas at first this may appear an onerous obligation you should remember that even if you owned the Freehold of the property you would still have to maintain it. It is clearly less likely to be to your advantage to do substantial alterations to a Leasehold property, and indeed you would require your landlord's permission to do so.
Normally leases have only one 'variable factor' and that is the rent; this will be subject to review from time to time during the lease (usually every 3, 4, 5, or 7 years), and when these reviews occur it is for the landlord and his tenant at that time to mutually agree upon the fair market rent for the premises and if they are unable to reach agreement there is usually provision for an arbitrator to be appointed or for the matter to be taken to a rent tribunal. It should be noted that the rent to be agreed upon review (or upon renewal of the lease) is not in any way relative to how well or badly the business may be doing at the time, it is purely a matter of what the property could be let for on the open market bearing in mind the 'restrictions' as to how the premises may be used, etc which may be contained in the lease Although it may seem that these rent reviews present an opportunity for constant disagreement between landlord and tenant, it is a fact that in the vast majority of cases agreement is quite quickly and amicably reached. The tenant realises that he must pay a reasonable 'going rate’ and the landlord, although naturally wanting to get as high a rent as possible)- also realises that the tenant has' to make a living and a slightly lesser rent from a good tenant who pays his rent promptly is more valuable than a higher rent which he has to fight to get every quarter.
However long the lease may be to start with, sooner or later it will come to an end, and this is the thing that worries many people about leases. The most common misunderstanding people have is that when they come to the end of the lease they will have to pay the landlord a substantial premium to renew it, and this is simply not the case. Usually people are confusing this with the premium they pay when they buy the business in the first place. This premium is said to be for the 'fixtures, fittings, goodwill and the lease’, but put more simply you have bought the 'existing business' and that business is then yours to do with as you wish. So, If you chose to transfer the business to other premises (say a larger shop next door), you would be quite entitled to do so provided you honoured all your obligations under the lease you purchased right up to the last day of the term of that lease. If you wished to renew the lease (which is usually the case) it is simply a matter of agreeing with the landlord the terms for the new lease (frequently almost identical to the old lease) and agreeing the fair market rent which you should pay for the first period of the new lease - you pay no premium to the landlord. Another major worry people have about buying Leasehold businesses is renewal of the lease when it expires. Have you any right to renew? Well, the answer is a resounding YES! The Landlord and Tenant Act of 1954 offers the tenant of business premises very considerable rights of renewal, provided that he has been a good tenant paid his rent and observed his various obligations under the terms of the lease. There are situations which may occur where the landlord is not obliged to grant a new lease, but in fairness they can be said only to occur very occasionally and may usually be anticipated (for example where the property is the subject of a compulsory purchase order to enable the local authority to drive a new road through the area - this sort of situation may be fore seen several years ahead). The important thing to remember is that landlords (whether they are individuals or property companies) are normally 'Investors', their Investment is in the property you occupy and their 'return' is the rent you pay. If you have been a good tenant, and you are willing to pay the current market rent, they would be stupid not to wish to renew the lease with you - the property earns them nothing if it is empty and there is no point in changing from a good tenant you know to an unknown! Tenant if they are both willing to pay the same rent. There are advantages to buying a Leasehold business (as against buying a Freehold one). The most important one to most people is that because you are not buying the property the proposition is very much cheaper in the first place; but there is another advantage which few people seriously consider, and that is that leases do come to an end! So often people say they wish they could buy a business with. a lease of 50 or 60 years, but they do not realise that once they take 'the lease they are committed to the whole of it. The business may well become too big for the premises or indeed the nature of the business or the demands of the area may change, a lease which has a positive end from time to time gives the tenant an opportunity to change premises or change the terms on which they occupy the premises (for example change the lease of a 'grocers’ to incorporate 'health foods, delicatessen and news agency’) these changes are only really possible when agreeing the terms for a new lease.
This brief information may well raise further queries in your mind, please feel free to phone and discuss them with us –
01404 813762 / 813952
EVERETT MASSON & FURBY
Helping you to buy a better business
