Break Options: Deal or No Deal?

Published: 30th September 2009

Break options have had a relatively short life in the context of commercial property. Resisted by landlords, desired by tenants and contested by lawyers interpreting what constitutes effective determination. The current economic downturn and moreover the speed of decline has brought a different, commercial focus on break clauses and their value in the present market.

With the rate of decline in UK commercial property values slowing noticeably from the freefall of 2008, many property investors with an eye on their funding facilities and loan to value (LTV) covenants are conducting revaluations with growing frequency.

For the independent valuer, break options represent a landmark where the proverbial income stream cascades over the edge of the waterfall leaving values to plummet. Coupled with record void occupancy levels, low occupier confidence and declining rental values, the valuer faced with a break option could be forgiven for assuming the worst.

But break options, like other contractual terms are capable of variation. Even if tenants have no genuine intent of exercising their break clause, re-gears to remove or move out the effective break date provide the certainty of additional revenue for the valuer to capitalise. How much value is generated is clearly dependent upon a range of factors including the tenants covenant strength, residual lease term, rental level, market sector and location.

Market conditions have provided a catalyst for landlords and tenants to work collaboratively to their mutual benefit. For landlords, sharing part of the value uplift from lease and break option re-gears is a far better place to be than breaching their LTV covenants and risking foreclosure. For tenants, commercial awareness of the opportunity and the benefit of a rent free period or capital payment from the landlord provide a welcome windfall to their bottom line costs when the top line is invariably contracting.

The 'deal or no deal' question can end or extend a property investors activities in today's challenging market environment but collaborative lease engineering can be rewarding for both sides of the occupational divide.