Dilapidations in an Economic Downturn - helping our clients deal with dilapidations in difficult times

When economic conditions are tough, surveyors can add significant value for their landlord and their tenant clients by adopting a collaborative approach.

Dilapidations is a mechanism or legal process to address breaches of a lease contract that have caused an injured party, usually the landlord, to suffer a financial loss. 

In difficult economic times, robust, strategic support with dilapidations matters can make a weighty difference to our clients’ business circumstances. When different chartered surveying specialists work well together, we achieve great dilapidations results for our clients.

This article summarises hints and tips on 'doing dilapidations well' that author Gillian Murray conveyed during her presentation to the RICS Scotland Conference in November 2020. Dilapidations at various stages of a typical leasehold property cycle are discussed.

(Specific hints and tips are underlined in the narrative below.)

Tenant contemplates leasing

Different leasing arrangements each have different implications for the tenant’s dilapidations liability, for example, taking an assignment has different implications from taking a sub-lease. 

Take time to help your client understand what dilapidations entanglements it is getting itself into. Urge them to assess dilapidations as part of their due diligence exercise.

The dilapidations ‘dream team’ of the building surveyor and quantity surveyor, working closely with the client’s legal and agency advisors, can help clients understand how the leasing arrangements apply in real terms to the premises.

The resultant advice helps our clients build an allowance for any dilapidations liability or risks into their financial models and to make financial provision each year for dilapidations liabilities, which can help reduce their tax bills throughout the course of the lease rather than just at the end of the lease.

Tenant takes a lease

While the agent is busy negotiating the lease terms, the building surveyor’s experience of applying leases to buildings means they have a good ‘eye’ for clauses that tend to benefit the landlord or the tenant more in different circumstances. The agent and the building surveyor working closely together (and have a good understanding of what is trying to be achieved) benefits the client. A slight caveat, surveyors are not (and should not try to be) legal advisors so take care that it is only the application of the lease to the building that you advise on, not the interpretation of the lease.

The building surveyor’s advice on the merits or otherwise of annexing a schedule of condition to the lease can be useful because a schedule of condition is not always a helpful ‘add-on’ and ought not to be the default recommendation.

Tenant fits out premises

The tenant’s alterations and additions change the dilapidations landscape. There will be a licence for alterations most likely, and the licence obligations will ‘trump’ those of the lease and need to be understood clearly. 

The tenant will next need to adjust its dilapidations accruals and the building and quantity surveyors will support this with an updated assessment, which ideally would be in tandem with a review of potential fiscal incentives, e.g. capital allowances and the like, in connection with the tenant’s works. The surveying team’s advice can help the client minimise the overall financial impact of its project works.

Sale of premises

A prudent purchaser of the premises, perhaps advised by an investment agent, should ensure that yield calculations/values take account of the actual dilapidations existing at the premises rather than applying a general per square foot rate.

Take care to check that the technical due diligence survey does not make sweeping statements about dilapidations recovery, as these ought to be interrogated in more depth. It is important to unravel the risks and potential maintenance backlog or prospective capital expenditure shortfalls at the change of a tenancy.

Contemplating relocation

When the tenant begins considering ‘stay or go’ deliberations, particularly where it has a break option, the building surveyor working alongside the client’s agency surveyor can create great value for the client and help them to leverage every advantage in their commercial discussions.

It is common that the tenant’s dilapidations assessment might anticipate repairs to equipment at the break date but a requirement for replacement of the equipment by the end of the lease.  Armed with the dilapidations assessment data, the tenant’s agency surveyor might use this knowledge strategically in the lease negotiation, leveraging more favourable terms for the tenant if the tenant agrees not to exercise the break.

The agent’s advice will also be important when considering potential market conditions at the time of break dates and expiries are also important from a strategic perspective. Should the tenant do the works itself? If it does not, is it likely to face a loss of rent claim because the landlord has an armful of prospective tenants desperate to move into the premises once they are vacant? 

Claiming dilapidations

Avoid surprises where possible by encouraging landlord clients to have a dilapidations assessment or claim prepared well in advance of the lease expiry. Knowing what to expect and having an ascertained claim is also a very useful tool in the landlord’s box from a protecting itself in the event of tenant default or liquidation perspective. 

In these difficult times, maintaining relationships between landlord and tenant is a very important part of the negotiator’s role. It is likely that landlord clients need to keep the relationship with the tenant on the best of terms so as to attract them into another unit in the future. Guide your client but also take their guidance on how the relationship aspects ought to be factored into your discussions.

Be open and transparent with your landlord clients about the impact of their intentions for the property on any potential dilapidations claim. Management of expectations as to recovery of sums claimed is vital. There is almost always some degree of commercial compromise that must be brought to bear during negotiations.

Ideally, you will guide your client to expect a zone of potential agreement where the expected settlement is a range of best and worst case outcomes. Recognising that both parties will be trying to take advantage of so-called ‘grey areas’ in the lease can help smooth the negotiation; it’s not personal, try not to make it so. 

Tenant carries out works

Guide your tenant client to ensure compliance with lease terms. Take care not to do more than the lease requires.

Have regard to any break clause preconditions, highlighting to your client when their legal advisor’s input is required.

The lease and sometimes the licence for alterations will be prescriptive about what permissions should be in place for works to be considered permitted or licensed. Help clients understand and secure these permissions and to fulfil the letter of the lease requirements. 

Have regard to the time constraints around the time it will take to carry out the works – does the landlord have to serve notice of its reinstatement requirements? If so, what does the lease say about how much notice? If the lease is silent, what might be considered ‘reasonable’ notice given your jurisdiction?

Inform your clients how these sorts of considerations will impact their strategic choices or when it comes to deciding what to do regarding carrying out works; and they will impact the landlord client where time is of the essence in serving the notices required by the lease.

Evidencing loss

Landlords are increasingly aware that in most circumstances they will need to evidence loss associated with the tenant’s dilapidations. Guide them through the options available to them and draw in your valuation and agency counterparts to inform these when needed.

Should they do works? Would a diminution valuation or evidence of loss by other means be more appropriate? The surveyor team can set out strategic choices and help clarify risks and commercial considerations.

Settlement

As negotiations progress, keep the client’s best alternatives to no agreement under review. Are there arbitration or mediation or litigation dictats set out in the lease? What if the tenant entity goes into liquidation? How financially secure is the tenant entity in any event? What are the risks? How important is it to your client that the relationship is maintained? 

Once the dilapidations is agreed, advise your client to have their legal advisor draw up or review the settlement agreement terms. It is important that it is understood and accepted by the parties whether the agreement is full and final of just the dilapidations in the schedule, or of all breaches under the lease, or whatever the parties intend the agreement to say.

And repeat….

When the landlord moves to next re-let the premises or the tenant again faces its own choices regarding leasing premises, they will remember the sensible, good advice that you have provided.

Working together and taking a collaborative approach to helping our clients make strategic property decisions will mean that we are the natural choice to support them in future transactions. 

Our clients need chartered surveyors to support them in their strategic property decision making now more than ever.

We can help them mitigate risk and make the most of their investments, but to do so effectively we must work together and think broadly and widely around all the circumstances

Contact Author:

Gillian Murray BSc (Hons) MRICS

Head of Dilapidations and of Professional Building Surveying Services for AECOM Limited

M: +44-742-533-2400

E: gillian.murray@aecom.com

An abridged version of this article was published by the Royal Institution of Chartered Surveyors on 20 April 2021 at https://ww3.rics.org/uk/en/journals/built-environment-journal/dilapidations-strategies-to-help-clients.html