10 dilapidations questions occupiers should be asking
16 May 2022 12 Minute Read
To coincide with the publication of the second edition of our European Dilapidations Guide, we consider 10 questions that occupiers need to ask themselves – if they want a complete picture of their dilapidations liabilities. We also explain why expert professional representation is critical to reducing exposure to risk.
- Are we carrying the right financial provisions across the portfolio?
There can be huge differences in the estimated costs of meeting dilapidations liabilities from lease to lease, and from country to country. Having reliable and accurate assessments for each individual property will ensure you comply with the International Accounting Standards Board’s IFRS 16 Leases, and better align the provisions you’ve made with your liabilities.
- What are IFRS 16 Leases?
From 1 January 2019 a change in the International Accounting Standards set out that companies are obliged to include the assets and liabilities of any lease over 12 months on their balance sheets. This must include an accurate assessment of restoration costs, which are more commonly known as the liabilities for dilapidations and reinstatement.
- Are all appropriate steps being taken during the lease to mitigate liabilities and risks?
Considering your dilapidations liabilities throughout the lease will allow you to budget accurately, plan the necessary work to avoid business disruption, and at the same time spread and minimise the overall cost.
- How can you exit the lease at lowest cost?
Will you be using a lease break or the normal expiry of the term? Are there sub-tenants that need to be considered? What are the landlord’s intentions for the building after you leave? Answers to these questions (and more) need to form the basis of a specific strategy designed to reduce cost, manage risk, and increase certainty.
- Can there be wider cost risks that need to be both considered and avoided?
Some lease terms allow landlords to impose penalties if the tenant fails to complete dilapidations work before the end of the lease, (or agree an equivalent financial settlement). This can include rent for the time it would take to carry out the works, or even double and triple rent in some instances. Understanding these risks (and knowing how to avoid them) is critical to managing potential exposure to significant additional costs.
- Is the best option to negotiate a financial settlement or undertake the work?
Understanding each option clearly is fundamental to making the right choice, one that offers the most cost-effective solution to your exit. Sometimes, the right answer is a combination of both. The answer will lie in the specific lease and the local market the property is in. There may also be a tax or VAT benefit in doing (or not doing) the work which also needs to be considered.
- How should the building be decommissioned?
If a financial settlement is the preferred strategy, as a minimum typically all furniture and loose items need to be removed, leaving the premises presentable, clean and clear when you go. However, a more onerous lease could mean needing to achieve full compliance with all your obligations and accepting responsibility for a full package of works before the lease expires.
- Is there a difference if we exit the lease through a break option?
Most break options have pre-conditions which need to be met to successfully end the lease. The most commonly used terms like vacant possession, give up occupation, and material compliance all have meanings capable of varying interpretation and may require different standards to be met. Case law is the best source of what the Courts expect when it comes to compliance by the tenant. Knowing clearly what you must do and executing it correctly will be the critical factor in breaking a lease effectively.
- What part does sustainability play in dilapidations?
Sustainability is now at the heart of every aspect of real estate. Dilapidations obligations are defined by the lease but adopting green leases and encouraging dialogue between landlords and tenants offers limited benefits. A more ambitious, holistic approach would be needed to drive a more sustainable approach around the leasing cycle of a building. We will be issuing an article soon, focusing on this topic, so watch this space!
- When is the right time to consider dilapidations?
At any point during the lease! Having appropriate professional representation will allow you to understand your obligations, how best to mitigate the liabilities that flow from them, and how to save significant sums of money.
We are pleased to release the 2022 update of the European Dilapidations Guide, download this here.
If you have any more questions after reading this article or the European Dilapidations Guide, please get in touch.