To buy or not to buy the freehold

To buy or not to buy - That is the question?

Should you buy the freehold to your pharmacy, or lease it? What advantages do both options hold“Freehold or leasehold - which is the best for you? Freehold means the building is yours - you own it, you can see it, value it and sell it - the only obligations you have are to yourself- sound appealing doesn’t it, but is it really the best option?

With leasehold someone else owns the building - but you can occupy it under certain circumstances as defined in the lease. It sounds limiting but is not necessarily such an unattractive option.

A lease can be for more or less any defined period but it is important to differentiate between the two main types:

• Leases of less than 21 years original duration are generally known as tenancy leases. They do not usually attract an initial premium (unless in a prime site) but the rental payable will be directly related to the freehold value of the property - a rule of thumb average is 10% but it will vary, as the investment yield on property varies from time to time.
• Leases of longer duration and they can extend up to 999 years; tend to attract a premium and a lower annual rent. If the lease is for longer than say 50/60 years then you would pay a premium close to the value of the freehold but usually a nominal annual ground rent.
  

Whether one option is better for you than the other however, depends upon your circumstances and the figures involved. What is important to remember is that all premises have a cost whether freehold or leasehold.

If you do own the freehold, you don’t have to pay rent but you have either invested cash, or taken out a loan to buy it. You must judge whether you will get the best investment return from buying the freehold, or from expanding the existing business or acquiring another pharmacy.

Operating from leasehold premises and most pharmacies do, is almost as secure as owning the freehold. Although the landlord does have certain rights of repossession, it is very hard for him to evict you. Obviously you can be evicted if you do not meet the obligations of the lease and when the lease comes up for renewal there are circumstances under which he can refuse to renew it.

However, within the Landlords/Tenants Act, these are clearly defined and the landlord has to prove under one of the conditions before he can refuse to renew. For example, the landlord can demand the property back under the following conditions:

• Failure of the tenant to comply with repair and maintenance clauses
• Persistent delay in paying the rent
• Substantial breaches of obligation
• The landlord offers other suitable accommodation which is reasonable
• The current letting is an uneconomic sub-letting - it would be better to let the whole property
• The Landlord wants to demolish the property and redevelop - normally compensation would be offered
• If the landlord wishes to occupy the building himself

You are in control of points 1, 2 & 3 and in pharmacy; it is very rare for one of the other reasons to be applied. Most landlords would recognise that a pharmacy represents a secure and reliable tenant.

Nevertheless it still makes sense to ensure that there is at least 10 years left on the lease, if you are contemplating taking out a 10 year loan against the business.

Your principle obligations are to keep the property properly insured and in good repair (i.e. the same obligation you would impose upon yourself). But do be aware of any other specific responsibilities.

At acquisition, you should view a leasehold property no differently from a freehold one, - before you sign the lease, or buy the freehold, employ a qualified surveyor to structurally survey the property. The majority of leases are fully repairing leases, you will need to make good any repairs, so make sure that these are identified and agreed with the landlord at the outset. The existing tenant should rectify them before you take over, alternatively you should reduce the amount being paid for the goodwill of the business, to reflect the additional expenditure you will have to make.

Another issue to be aware of is the regularity of future rent reviews. Nowadays, with low inflation, rent reviews should be no more frequently than every five, or even seven years. However, when inflation was high, it was not uncommon for three years to be the norm; maybe you can use your powers of negotiation to alter this when you take over.

Of course, when the rent does come up for review, don’t just accept the figure proposed, the increase has to be reasonable and if the landlord won’t listen to reason, then there is an appeals procedure. If in doubt, seek professional advice.

What if you are a leaseholder and the opportunity comes up to buy the freehold - should you go for it? This depends on:

• the price
• the current rent
• the landlord
• the length of lease left

For example, if it is a reasonably sized pharmacy with £600k turnover and the freehold is valued at £70-80K, then it might be a good move, it is a relatively small investment and it takes out the hassle of dealing with a landlord. However, if you are in an expensive location and it is valued at £350K, with three or four flats above the pharmacy, then you must ask yourself, ‘do I want to be a pharmacist or a property developer?’ One sub-let can bring welcome extra income, but more can just be a headache and distract you from the pharmacy business.

No matter how keen you are, if you are just starting out, taking on a freehold is not always advisable. It increases the initial cash contribution you need to make, and might mean that you have to start with a smaller pharmacy than otherwise. Try and negotiate with the landlord for an option to buy the freehold in say, five years when the business is established, your initial loan has reduced and you are in a better position to take on further borrowing.

In summary therefore, whether buying freehold, or negotiating leasehold, you need to do three key things:

• Employ a qualified surveyor to get an accurate value of the property and any repairs that may need to be done.
• Employ a qualified solicitor specialising in property and leasing law to attend to the legalities for you.
• If you are negotiating a new lease, or a rent review, consider employing a property consultant specialising in lease negotiation, to act on your behalf.

A little expenditure in the right direction at the outset obtaining good advice could save you much heartache and cost later on.