What it means
Commercial leases usually contain promises by the tenant to keep the property in good repair and to return it in a specified state. They may also require the removal of alterations the tenant has made, such as partition walls or extra cabling.
If the tenant has not met these promises when the lease ends, the landlord can claim the cost of putting things right. The claim is normally set out in a document called a schedule of dilapidations, prepared by a surveyor.
It lists each breach, the work needed and its estimated cost. Landlords may also claim fees for the surveyor and, in some cases, rent lost while the work is carried out.
The amount a landlord can recover is generally limited, in many jurisdictions, to the actual loss in value of the property caused by the breach. If the landlord plans to demolish the building or redevelop it anyway, the claim may be much smaller than the cost of repair.
This is why tenants often negotiate hard on the final figure. For a finance team, dilapidations are a provision (a liability of uncertain timing or amount) that builds up during the lease.
Under accounting rules, if the company has an obligation and can estimate the cost reliably, it should record a provision. The estimate should be reviewed each year, because building costs and the condition of the property change.
Good planning reduces the bill. A tenant can survey the property a year or two before the lease ends, complete repairs on its own terms and agree with the landlord what is needed.
Doing the work through its own contractors is often cheaper than paying a landlord's claim. The negotiation often turns on what the lease actually says.
A clause that requires the tenant to keep the premises in good repair is read very differently from one that limits the duty to the condition at the start of the lease. Taking the original condition record and photographs along to the discussion can save a lot of money.
In practice
Real-world examples
Example 1
A law firm leaving a ten-year office lease receives a schedule of dilapidations for $140,000. Its surveyor challenges several items as normal wear and tear and negotiates the claim down to $95,000.
Example 2
A retail chain has a lease clause requiring it to remove its shopfit and restore the unit to an open shell. The finance team builds a provision of $60,000 per store and increases it each year as the exit date approaches.
Example 3
A warehouse tenant arranges a survey 18 months before the lease ends. It repairs the roof and floor with its own contractor for $70,000, while the landlord's initial estimate was $110,000.
Think of it
Imagine borrowing a friend's car for a road trip. Even if you enjoyed the drive, you must return it washed, with a full tank of petrol, and having fixed any dents you caused along the way. Dilapidations are simply the business version of returning that car in its original condition.
Formula
Calculation
Dilapidations claim = Cost of repair and reinstatement works + Professional fees + Loss of rent during works
Suppose a landlord's surveyor prices the necessary works at $85,000 and charges professional fees of $6,000. The landlord expects the building to be empty for three months while the work is done, at $9,000 rent a month. Loss of rent = 3 x 9,000 = $27,000. Total claim = 85,000 + 6,000 + 27,000 = $118,000, though the tenant may argue that the claim should be capped at the fall in the property's value.Case study
Seen in the real world
Brackenfield Consulting is an illustrative, fictional firm that rented offices for twelve years. It had never set aside money for the end of the lease, and the finance manager was surprised when the landlord's schedule arrived for $210,000, a large sum for a business with annual profit of $600,000.
The firm hired a surveyor, who found that about $60,000 of the claim covered work the landlord intended to do anyway as part of a refurbishment. After negotiation, the final settlement was $115,000.
The illustrative finance manager then introduced a rolling provision on all other leases, reviewed each year with a surveyor's estimate. The lesson was that dilapidations are a predictable cost, not a surprise, and that early planning can reduce them.
Watch out
Common mistakes
- Leaving all thought of dilapidations until the lease expires, when there is little time or room to negotiate or to carry out cheaper repairs.
- Failing to build a provision, so the cost hits profit in a single year instead of being spread across the lease.
- Accepting the landlord's schedule without a challenge, when many claims include items that are wear and tear or are not allowed by the lease.
Questions
People also ask
Are dilapidations the same as normal wear and tear?
No, because many leases do not require the tenant to repair ordinary ageing, though this depends on the exact wording.
Can the landlord claim any amount it wishes?
Not usually, because the lease and the law in many places limit the claim to the genuine loss to the landlord.
When should a tenant start planning?
Ideally one to two years before the lease ends, so there is time to survey, plan the work and negotiate.