Leasehold vs Freehold: The Basics
When you buy a business, you are not usually buying the bricks and mortar. The vast majority of commercial businesses in Brighton, Hove and across Sussex operate from leasehold premises. Understanding the difference between leasehold and freehold, and the implications of each, is essential for any business buyer.
What Is a Leasehold?
A leasehold gives you the right to occupy and trade from a property for a fixed period, as set out in a legal document called the lease. You do not own the building; instead, you pay rent to the freeholder (landlord) for the right to use it. When the lease expires, the property reverts to the landlord unless the lease is renewed.
Most commercial leases in the Brighton and Hove area run for terms of 10 to 25 years, though shorter and longer terms exist. The lease will contain detailed provisions covering rent, permitted use, repairs, alterations and many other matters that directly affect how you can operate your business.
Key Lease Terms Every Buyer Must Understand
Rent and Rent Reviews
The lease will specify the annual rent and how often it is reviewed. Most commercial leases include rent review provisions, typically every 3 to 5 years, where the rent is adjusted to reflect current market values. Some older leases contain upward-only rent review clauses, meaning the rent can only increase or stay the same at each review, never decrease.
Lease Length
The unexpired term is critical. A lease with 15 or more years remaining provides long-term security, while a lease with only 3 to 5 years left may make it difficult to recoup your investment. It is worth noting that under the Landlord and Tenant Act 1954, most business tenants have a statutory right to renew their lease at expiry, though the terms of the new lease may differ.
Assignment
When you buy a business operating from leasehold premises, the lease is "assigned" to you. Most leases permit assignment but require the landlord's consent, which cannot be unreasonably withheld. The landlord will typically want to satisfy themselves that you are a suitable tenant with the financial means to pay the rent.
User Clause
The lease will specify what the premises can be used for. Some user clauses are restrictive (e.g., "use as a restaurant only"), while others are broader (e.g., "use within Class E of the Town and Country Planning Use Classes Order"). If you plan to change the nature of the business, check the user clause carefully.
Repairing Obligations
Commercial leases typically place repairing obligations on the tenant. A "full repairing and insuring" (FRI) lease makes the tenant responsible for all repairs to the property, including the structure and exterior. An "internal repairing" lease limits your obligations to the interior only. Understanding your repairing obligations is essential for budgeting.
Break Clauses
Some leases include break clauses that allow either the landlord or tenant (or both) to terminate the lease early at specified dates. A tenant's break clause can be valuable, providing flexibility if the business does not perform as expected. However, break clauses often come with strict conditions that must be met precisely.
What Is a Freehold?
A freehold means you own the building outright, along with the land it sits on. There is no lease, no landlord and no rent to pay. You have complete control over the property, subject to planning regulations and any restrictive covenants.
Pros and Cons for Business Buyers
Leasehold Advantages
- Lower upfront cost compared to buying a freehold property
- Capital can be invested in the business rather than tied up in property
- The landlord is often responsible for structural repairs (depending on the lease)
- Greater flexibility to relocate when the lease expires or at a break date
Leasehold Disadvantages
- Ongoing rent payments reduce profitability
- Rent reviews may increase your costs significantly
- Restrictions on alterations, use and assignment
- No capital appreciation from rising property values
- Lease expiry creates uncertainty about the long-term future
Freehold Advantages
- No rent to pay, improving cash flow and profitability
- Full control over the property without landlord restrictions
- Potential capital appreciation as property values increase
- Can be used as security for business borrowing
- Can generate additional income by letting surplus space
Freehold Disadvantages
- Significantly higher purchase price
- Full responsibility for all repairs and maintenance
- Capital tied up in property rather than the business
- Less flexibility to relocate
Which Is Right for You?
For most small business buyers, leasehold is the practical choice. The lower capital outlay allows more funds to be invested in stock, marketing and working capital. However, if you have the resources and find a freehold opportunity in a good location, the long-term financial benefits can be substantial.
Whatever your situation, professional advice is essential. At Watkins Commercial, we can help you understand the lease terms of any business you are considering and advise on whether the deal represents fair value. Contact us on 01273 709090 for a confidential discussion.