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22
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22 (117) 2015
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Real Estate & Construction

Risk factors in office lease agreements

by Tomasz Dyła, commercial real estate broker and managing partner, Vertigo Property Group.
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The lease rent and other payments associated with the lease of a commercial office space constitute a significant part of costs incurred by a company. In the case of lease agreements, they also form long-term liabilities. Concluding a lease agreement therefore, although it undoubtedly offers a company many opportunities for development, may also  pose certain risks.  

This article presents an overview of basic types of risk associated with the office space lease agreement, from the tenant’s point of view. 

The risk associated with the term of the lease agreement

One of the basic risk factors for a tenant concluding commercial lease agreements is the lease period of the agreement. The decision concerning the term of a lease agreement should be thoroughly thought over as it may entail several risks. The lease agreement can be concluded for a specified or an unspecified period of time. 

The decision to conclude an agreement for a specified or an unspecified period of time should be influenced by a variety of aspects which are characteristic for a particular company. The interests of the landlord and the tenant concerning the term of the agreement are often divergent. Negotiating an agreement, one should analyse the actual indications of both parties concerning the choice of a specified/unspecified period of time, which can significantly enhance the efficacy of the negotiations and protect both parties’ interests. 

The risk associated with rent indexation 

The landlord and the tenant may agree on the lease rent being not changed during the whole term of the lease agreement, however on a commercial market this happens quite rarely. Most commonly lease agreements include a yearly increase of the lease rent, known as indexation, made on the basis of an index agreed by both parties of the agreement. The choice of a proper indexation of the lease rent, properly adjusted to a particular type of a lease agreement, is of great significance. 

A variety of indices are used in commercial lease agreements and their choice is usually determined by a currency denominating the lease rent. The most common inflation indices are those based on the general Consumer Price Index (CPI). Another important risk factor associated with the indexation of the lease rent is also its frequency and term. 

The risk associated with the change of ownership of a property during the lease term

Another significant risk a tenant may face is the change of ownership of a property during the term of the lease. This is particularly common on a commercial market, where properties are often treated as products of investment.
In the event of the property being sold, the new owner legally becomes its landlord. This does not entail any changes in the provisions of the concluded agreement, but the new landlord is in this situation entitled to terminate the agreement, preserving the statutory notice period, regardless of the terms stipulated in the agreement. It poses a significant risk for the tenant who may be forced to vacate the leased space before the termination of the agreement or to renegotiate the lease rent. The tenant should be aware of the fact that Polish legal regulations still protect them from any unfavourable effects of the change of the property ownership. 

Foreign exchange risk associated with the lease rent 

On a commercial market, due to the specification of the loan taken by the real estate owner, the lease rent is often stated in a foreign currency and is each time exchanged into the equivalent amount in Polish zlotys, which exposes tenants to exchange risk, one of the basic risk factors in any international business activity. 

In the current market situation, office space lease agreements are usually stated in euro and the payments are made in PLN on the basis of an average exchange rate published by the National Bank of Poland (NBP). Most companies operating in Poland favour lease agreements stated in zlotys as they are safer. Commercial practice observed in the recent years shows that many landlords adopt a more lenient exchange rate policy, and allow for the lease rent to be expressed in zlotys.

The risk associated with the service charges

Service charges constitute a significant part of costs incurred by commercial building tenants. They cover expenses and costs associated with the functioning of a building, including its common parts. In A-class buildings, situated in best Polish locations, their value is estimated to be 20-25% of total lease costs. Service charges are a significant and controversial element of each lease agreement due to the fact that they are impossible to predict in detail, as their amount is usually stipulated to be paid in advance. And in many buildings, the catalogue of service charges is not finite. Therefore, in view of the keen competition between owners of the buildings and the growing awareness of tenants, a general tendency towards lowering the service charges, which have a significant impact on negotiating the lease agreement conditions, has been observed in the recent years. 

Insurance 

Insurance is a significant element of each lease agreement as it eliminates the potential risks associated with concluding it. Under the terms of a lease agreement, both parties are usually obliged to insure a property concerning two basic elements: the property itself and the civil liability. When negotiating the lease agreement, it’s vital to stipulate who’s obliged to ensure a property, what’s covered by the insurance, who pays for it and what the consequences of lack of insurance may be. 

The risk associated with the change of the lease rent during the term of the lease

Conflict over the possibility and the terms of increasing the lease rent is often observed between both parties of a lease agreement. Regardless of the provisions concerning the lease rent indexation, the regulations of the Civil Code stipulate that the landlord is entitled to increase the lease rent during the term of the lease agreement. Lawyers still argue whether lease rent can be terminated in the agreements concluded for a specified period of time or only in the case of agreements concluded for an unspecified period of time. There are several ways, however, to ensure protection against the above-mentioned situation. One of them is, for instance, the exclusion of the relevant Civil Code regulations from the lease agreement. 

Summary

This article presents but a selection of risk factors a tenant may face when concluding commercial lease agreements; the list is necessarily more comprehensive. The analysis of the above-mentioned risk factors of a lease agreement seems essential in the process of consciously managing the risks of running a company and is vital for the overall real estate policy of a company. 

 

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