Issues which affect the property leasing market across Europe

Does the European FRI Lease exist?

Louise Anderson and Bruce Dear look at the issues which affect the property leasing market across Europe

Market forces and the E.U. governments have begun to create something which 2000 years of intermittent warfare failed to achieve: a single European market with a single currency.

Business practice, though, is well in advance of legal and political structures. Investors and tenants are already treating Europe as a de facto single market and demanding expert advice within each state.

Some of the points at stake can be illustrated by focusing upon an essential feature of the property investment market - the lease. Investors and tenants in England are familiar with the 'FRI' or 'net' lease. If well drawn, it delivers an income clear of costs to the landlord with sustainable management responsibilities. The tenant pays all the running expenses and gives covenants to preserve the property's value. However, other jurisdictions may well find the FRI lease an alien concept. In the words of a representative of Blackstone, the powerful American investment firm:

'Although highly financiable, we find that [the FRI lease] is a little too inflexible to be transplanted wholesale to the European mainland. Our approach in Europe has been to be sensitive to tenant demands, whilst asking for longer terms in return.'

This article compares leases in the English market with those in three Eastern European markets: the Czech Republic, Hungary and Poland. It is an extract from a detailed survey of the European Occupational Investment Lease across nine jurisdictions1.

Tenants

Security of Occupation

• Virtually all businesses need the security of knowing for how long they will be able to occupy their premises. In England, although there are provisions for opting out, statute limits the grounds upon which a landlord can remove a tenant from occupation. Tenants may also apply for a new lease at market rent. By contrast, tenants in the Czech Republic and Hungary enjoy no statutory rights of continued occupation, nor any renewal rights at the end of a lease. In Hungary, contractual extensions of 3-5 years have become common practice, with third party or Court determination of rent in default of agreement. The tenant's position is more precarious in Poland; a purchaser of the landlord's interest may be able to terminate leases after buying the property.

Rent Reviews

• Generally in England leases are drawn to prevent rents dropping below the level existing before each five yearly review. Elsewhere in Europe indexation is the main method of review. Common practice in the Czech Republic, Poland and Hungary is a review on each anniversary of the lease, tracking a particular inflation rate depending upon the lease's chosen currency. Landlords in the Czech Republic are beginning to seek further reviews to market rent on an upwards only basis at intervals during the term.

Service Charge

• Service charge is the mechanism used by landlords to shield their rental income from the burden of providing services to a building. In England, many institutions will not purchase buildings without properly drawn service charge provisions. In Eastern Europe, there has been a move away from inclusive rents towards a system of service charges, although these only relate to some costs. Tenants should, however, be warned of a number of rogue landlords in the Polish market, who charge fixed sums for services per square metre, provide little in return and keep the money as 'bonus' rent.

Landlords

Lease Term Periods

• Lease terms have been shortening in England from the traditional 25 years to periods of 10 or 15 years. Nonetheless, longer terms are still preferred by landlords. Traditionally, other jurisdictions have been more comfortable with shorter time frames. The Hungarian market sports terms of between 1 and 5 years. In the Czech Republic, terms of 5 to 10 years are becoming increasingly common. In Poland, occupational leases are usually limited by statute to 10 years.

If granted for a longer term they become indefinite, albeit terminable by notice.

Landlord's Right to Terminate on Breach

• The Courts view the right to forfeit as the landlord's ultimate sanction against breach of covenant. If the Tenant makes good the breach in issue, however, and undertakes to mend his ways, the Courts will usually save his lease. No such right is available to tenants in the Czech Republic. The landlord's position is virtually as strong in Hungary, where forfeiture is known, rather ominously, as 'termination with immediate effect'.

A tenant in breach in Hungary does receive prior notification of termination, but can do little to avert it.

The Polish Civil Code gives more priority to tenant protection. The rent must be a certain period in arrears before the right to terminate arises. The tenant then has one month's grace in which to pay before the right to terminate 'bites'.

Long before formal documents are signed jurisdictional differences may trip the unwary. In the English market, heads of terms are not legally binding. In civil jurisdictions, they often do have contractual effect. The ill advised could find themselves stuck with a deal they thought that they were still talking about, or, conversely, find that their 'deal' does not secure them a contract.

Commercial property opportunities in Europe abound. In the East, the Polish, Czech and Hungarian economies remain sound. In the West, the coming of 'Euroland' brings unparalleled possibilities for cross border transactions. Organisations attuned to these developments, supported by a 'blue chip' network of European advisers, will have the opportunity to grow on an unprecedented scale. Those who miss out will find themselves trapped in the parochial, and increasingly unprofitable, confines of the one nation market.