State of affairs: The cost of dilapidation

Taking on or exiting a lease is a stressful enough experience but the word ‘dilapidations’ strikes fear into most licensees.

Dilapidations are the repairs that need to be made to the property to bring it back to the condition it was when the full repairing and insuring (FRI) lease was entered into. And dilapidations can be costly.

The notion is that the property is handed back to the landlord in the same condition as when it was leased.

Savills director of licensed leisure Kevin Marsh says: “The landlord should not be getting a property back at the end of the lease that is significantly worse than when he gave it to the tenant at the outset.”

When the lease is first issued, the obligations of the lessee are set out in the terms.

“Most leases state that the licensee is required to keep the property in a substantial or good repair. It can mean the most minor of details such as regrouting the tiles in the loos,” says Marsh.

“It covers all structural work, windows, doors, plumbing, heating, wiring and everything. Everything that will be required to hand back to the landlord in first-class order at the end of the lease.”

One area where some licensees may have problems is at the reassignment of a lease. Marsh says it is an area where lessees/tenants can become “unstuck”.

The licensee needs to take advice, have a survey conducted, know what needs to be repaired and what the costs are likely to be. “The licensee taking the property on assignment will not have seen the property condition at the outset of the lease and won’t have been able to influence the repairing obligations or the liability they are taking on,” Marsh says.

“They have to make sure that whatever price they are paying for their assignment it takes into account what it is they are about to inherit.”

Another area where lessees have hit trouble is with the terms of the lease. Many have a stipulation that if the new operator who has been reassigned the lease fails, the responsibility to pick up the bill can end up back with the original licensee.

“If at the end of the lease there are a lot of dilapidations and the tenant can’t afford them, then the last tenant becomes liable,” advises Marsh.

Towards the end of any lease the landlord will serve a terminal schedule of dilapidations that sets out all the things the operator, in the landlord’s opinion, needs to do to bring the property back up to the level of its original condition.

This is where the licensee can get a shock. Dilapidations can be costed at thousands of pounds, which they cannot afford. But all is not lost because the licensee is able to do the works themselves or hire someone to do them and it is likely to be at a fraction of the cost detailed in the schedule.

“There is no incentive for the landlord to find the very best cost or the cheapest contractors out there,” says Marsh.

However, on the expiry of the lease if there is no opportunity to complete the works the licensee must pay the monetary value to the landlord – even if the costs of the works is inflated.

Major pitfall

There is another major pitfall. The operator can also become liable for the landlord’s loss of rent if the property is in poor condition and cannot be re-let until those works are carried out.

But it is not all bad news because there is a cap on the liability. The licensee is only responsible for the landlord’s loss of value. For example, if there are plans to redevelop the property that would exempt them from liability.

Guy Simmonds managing director Stephen Taylor agrees that reassignment and expiry of the lease is a “thorny issue” for dilapidations. He says many licensees have had insufficient monies to keep investing in the upkeep of the property.

“This is further exacerbated if the rent has been excessive and/or trade had declined since the lessee took over the lease. Invariably and understandably, lessees under severe financial pressure struggle just to ‘keep their heads above water’ and continue to trade, let alone find the monies for compounded property repairs relating to many years of occupation,” Taylor says.

Another pitfall with the reassignment and dilapidations is that in most cases a corporate landlord will, as part of an assignment pack, request a fee from the licensee to cover the cost of a surveyor who will carry out the schedule of dilapidations, he warns.

“Any approval to reassign will often only be granted if the repairs specified by the surveyor have been completed to the surveyor’s/landlord’s satisfaction,” he adds.

However, one element of dilapidations that can work to the benefit of the operator is that some landlords have introduced regular property reports. This helps to monitor dilapidations and helps the licensee keep on top of any repairs. “Some pragmatic landlords undertake a regular property report (schedule of dilapidations) and present it to the lessee every two to three years or so. This can actually work in the lessees’ favour, since not only is essential preventative maintenance/guidance often highlighted, but also this frequency results in smaller amounts of necessary works being carried out on a sensible annual budget,” he says.

Taylor argues that while a landlord may allow an incoming lessee to take responsibility for the specified dilapidations it may insist on a further bond to be paid to the landlord, to ensure they are fully protected.

Common practice

Barry Alldread, sales director at Davey & Co, agrees this is common practice. He says that “nine times out of 10, the licensee will have to put that as a repair or dilapidation deposit with the landlord”.

He advises licensees to keep on top of their property maintenance and not take the landlord’s schedule of dilapidations as the cost.

“If you had a dilapidations report for £30,000, the true dilapidations is probably £12,000 or £15,000 because they are always overinflated as they price it on individual jobs as opposed to one person coming in and doing it all,” he says.

He cites one example seen by the agent when a pubco charged £150 for a cracked tile in the toilet. However, he says that all leases and dilapidations have a level of negotiation.

“If the buyer takes on the responsibility of dilapidation work then the landlord will come back and put a timeframe on the work to be done. This tends to be about six months,” he says.

Morgan & Clarke director David Morgan says that there is a huge issue concerning the timing of the dilapidations schedule. He warns that the whole system is open to “manipulation and abuse” but says that “reasonableness” is essential.

“If a schedule is served very close to the date of determination and it is quite impossible for the outgoing tenant to fully comply, the pubco or brewer will then use their estimate of costs as a direct deduction from settlement monies that would include value of inventory security, deposit and the asset of stock and consumables on the day of change,” he warns.

There is also an automatic requirement for a terminal schedule of dilapidations in the issuance of a market-rent-only (MRO) option offer, which he considers is wrong.

“Serving terminal schedule in conjunction with MRO full response is decidedly premature and does not guarantee that the tenant will take up the new five-year lease.”

Another area where he believes licensees can be hit is on assignment. The licensee is not liable for the dilapidations if the premises is to be completely refurbished by the new operator.

“However, the business plan of the new tenant is never shown to the outgoing tenant,” he warns.

Dilapidations can be a hugely costly experience for any licensee. But keeping on top of any repairs is an essential way to ensure that there are no big surprises at the end of the lease.