Goodwill in Commercial Letting: Meaning, Valuation, Legal Treatment in Kenya, and Practical Market Examples

Goodwill in Commercial Letting: Meaning, Valuation, Legal Treatment in Kenya, and Practical Market Examples

Goodwill is a frequently misunderstood concept in commercial real estate, particularly in commercial letting, lease assignments, and business transfers. It often becomes a point of contention between landlords, tenants, and incoming occupiers, especially in prime retail locations, hospitality spaces, and high-traffic commercial areas.

In commercial letting, goodwill represents an intangible but measurable economic value arising from the ability of a business to generate income due to its location, reputation, customer loyalty, and established operations at a particular premises. While goodwill does not form part of the physical property, it can significantly influence leasing decisions, business sale prices, and occupancy demand.

This article provides a comprehensive and Kenyan-contextualised explanation of goodwill in commercial letting, covering its meaning, legal treatment under Kenyan leases, valuation methodologies, legality of landlord demands, and real-world examples across retail, hospitality, and office markets.

What Is Goodwill in Commercial Letting?

In commercial letting, goodwill refers to the intangible commercial advantage attached to operating a business from a specific premises, beyond the value of the lease itself and the physical property.

It reflects the ability of a business to earn above-normal returns due to factors directly associated with its location and trading history.

Key elements that create goodwill

Goodwill typically arises from a combination of:

• Strategic or prime location

• Consistent customer footfall

• Established customer base

• Brand recognition linked to the premises

• Longevity of business operation at that location

• Limited competition within the immediate catchment area

• Favourable trading environment (access, visibility, zoning)

In commercial letting, goodwill is most commonly realised when an existing tenant sells a going concern business or assigns a lease to a new occupier.

Goodwill vs Rent vs Property Value

A critical distinction in commercial real estate is that goodwill is not rent and is not property value.

• Rent reflects the market consideration payable for occupation of space.

• Property value reflects the capital value of the real estate asset.

• Goodwill reflects the value of the business advantage associated with operating from that space.

For valuation and professional practice, market rent must always be assessed independently of goodwill.

Goodwill Treatment Under Kenyan Commercial Leases

Legal nature of goodwill in Kenya

Under Kenyan law, goodwill is generally treated as a business asset, not a real estate asset. It belongs to the business operator (tenant) rather than the landlord, unless expressly stated otherwise in the lease agreement.

Kenyan commercial leases typically:

• Grant occupation rights, not business ownership

• Do not automatically transfer goodwill to the landlord

• Require landlord consent for lease assignment or transfer

Lease assignment and goodwill

In practice, goodwill arises during:

• Sale of a going concern

• Assignment or transfer of a commercial lease

• Change of business ownership while retaining the same premises

Most Kenyan leases require that:

• The landlord consents to the assignment

• The incoming tenant meets financial and operational suitability tests

• The lease terms remain unchanged unless renegotiated

Importantly, landlord consent does not create an automatic right to charge goodwill.

Can Landlords Lawfully Demand Goodwill in Kenya?

General legal position

In Kenya, landlords cannot lawfully demand goodwill simply for granting consent to lease assignment, unless:

• The lease expressly provides for such a payment; or

• The payment is structured as a legitimate lease premium or variation consideration.

If a landlord demands payment purely to allow access or consent, this may be construed as key money, which is legally contentious and often discouraged in professional leasing practice.

Distinction between goodwill and key money

Goodwill is generally lawful when paid between tenants, whereas key money paid to landlords without contractual basis may be challenged.

How Goodwill Is Valued in Commercial Letting

Goodwill valuation is a specialised exercise typically undertaken during business sales, lease assignments, or dispute resolution.

Common goodwill valuation methods

1. Income-based approach (most common)

This method assesses goodwill based on:

• Historical business profits

• Excess earnings attributable to location

• Sustainability of future income

It isolates profits above a fair market return on tangible assets and rent.

2. Turnover multiple method

Often used in retail and hospitality, where goodwill is estimated as:

• A multiple of annual turnover

• Adjusted for location quality, lease term, and competition

3. Market comparison approach

This involves comparing:

• Similar businesses sold in similar locations

• Known goodwill premiums paid in comparable transactions

Key factors affecting goodwill value

• Remaining lease term

• Security of tenure

• Rent level compared to market

• Business performance trends

• Exclusivity clauses

• Zoning and licensing certainty

Goodwill value can diminish rapidly if lease tenure is short or renewal rights are uncertain.

Practical Examples of Goodwill in Key Commercial Sectors

1. Retail market

In prime retail locations such as CBD streets, shopping malls, and neighbourhood centres, goodwill is often significant.

Example:
A long-established retail shop on a busy Nairobi high street may command goodwill due to:

• Consistent pedestrian traffic

• Strong visibility

• Established customer loyalty

Incoming tenants are often willing to pay goodwill to inherit this advantage.

2. Hospitality sector

Restaurants, cafés, bars, and hotels frequently carry substantial goodwill.

Example:
A restaurant located in a popular entertainment district may derive goodwill from:

• Location-driven patronage

• Existing licences and approvals

• Reputation tied to the premises

Even when rebranded, the site itself continues to attract customers.

3. Office and professional spaces

Goodwill in office letting is less common but still present in specific circumstances.

Example:
Medical clinics, legal practices, or consultancy offices near hospitals, courts, or financial districts may benefit from:

• Referral traffic

• Location-specific credibility

• Client convenience

Here, goodwill is often modest but still measurable.

Risks and Limitations of Goodwill in Commercial Letting

• Goodwill does not survive lease termination

• Landlords do not guarantee business performance

• Poorly drafted leases can extinguish goodwill value

• Regulatory or zoning changes can erode goodwill

• Overpaying for goodwill can undermine business viability

Professional advice is critical before entering any goodwill-based transaction.

Best Practice for Tenants, Landlords, and Investors

• Ensure leases clearly address assignment and transfer rights

• Separate rent negotiations from goodwill discussions

• Conduct independent goodwill and rental valuations

• Seek legal and valuation advice before paying or demanding goodwill

• Assess lease tenure security before attributing value to goodwill

Goodwill in commercial letting represents the economic value of trading advantage attached to a specific location, rather than the physical property itself. In Kenya, goodwill is primarily a business asset belonging to the tenant, not the landlord, and its treatment depends heavily on lease terms, legal compliance, and market practice.

Understanding how goodwill works, how it is valued, and when it is lawful is essential for tenants, landlords, investors, and professionals operating in Kenya’s commercial property market. When properly assessed and documented, goodwill can be a legitimate and valuable component of commercial transactions—when misunderstood, it can lead to disputes, financial loss, and legal exposure.