Rent review provisions in commercial leases allow the landlord to review the amount of rent payable by a tenant during the term of the lease. They generally occur at intervals, for example every three years, and can be on an open market basis or by reference to certain indices. There are various other technicalities which can be thrown into the mix such as compounding, caps (i.e. maximum increases) and collars (minimum increases).
Any rent review must be carried out in accordance with the procedure set out in the lease and it must be documented by way of rent review memorandum once an agreement has been reached.
What are open market upward only rent reviews and how do they work?
An open market rent review is the most common type of rent review, meaning the rent is assessed based on current market conditions and trends, taking into account certain specified assumptions as to what the lease will contain and disregarding other factors in the interests of fairness.
An ‘upward only’ rent review means the rent will be reviewed to the higher of:
- The market rent at the date of the review; or
- The rent that was being paid at the rent review date.
This means the rent will either stay the same or increase – it cannot decrease.
Why does the Government want to ban upward only rent reviews?
‘Upward only’ rent review clauses are favoured by landlords, who are guaranteed that their rent will not decrease, even if market conditions are poor. However, these clauses can be unfair to the tenant if the market falls, as the tenant would be paying rent that no longer reflects the market value of the premises. This means that certain sectors such as the retail industry could be stuck with unaffordable rents, and may have to close their businesses as a result.
The Government has now proposed a ban on ‘upward only’ rent review clauses.
What does the English Devolution and Community Empowerment Bill propose?
The ban will remove the Landlord’s ability to insist on provisions which prevent the rent from falling. Under the proposals, the ban would only apply to leases which are being occupied for business purposes, and the ban will only affect new leases granted after the new law comes into force. There will also be anti-avoidance provisions, for example tenants will have the right to initiate the rent review process if the landlord chooses not to in a falling market.
What could the ban mean for landlords?
The change is likely to reduce income predictability and stability for landlords and there is also the potential for some investors to be put off by the change, as they typically favour upward only income over long periods of time to see the best return on their investment. Landlords may need to rethink lease structures to take this into account.
What does this mean for tenants?
The Government’s aim is to give tenants more bargaining power. However, there is a potential for landlords to perhaps set a higher initial rent to soften the blow of any later review which may see the rent reducing, or to favour shorter leases without rent review clauses. So tenants may see higher rents and less availability in the market. The proposal also has the potential to increase disputes between landlords and tenants over rent reviews.
What should landlords and tenants be doing now?
The bill is in the early stages and is not yet law. It has also come out of the blue without prior consultation of the property industry. It is likely that the proposal will change and develop over time, but both landlords and tenants should remain alive to the fact that this is in train, and it remains to be seen what further changes are to come and if the legislation is enacted in time.
If you wish to discuss this further please contact our Real Estate team or call 0345 540 5558.