Rent Review, how it works.
For businesses which rent their premises, a letter from the landlord advising that ‘its time for the rent review’ can get the managements blood pressure soaring. For tenants and landlords alike it is important to have a good understanding of what the rent review provisions in the lease mean and how they will be implemented in practice, as not all rent review clauses are the same and some can result in quite dramatic and unexpected increases of rent.
What does your lease say?
At your rent review you need to understand what your lease says and how the rent review provisions work. The rent review can take place in various ways.
The main types of formulae are as follows:
- Current Market Rental – this is based upon comparable rents in similar premises in the same vicinity. This is usually worded so that the rent is never less than the current rent i.e. “upwards only”. This is by far the most usual method. In this case the parties are required to agree the actual rent to be paid from the relevant review date by reference to the rent that would be payable were the premises to be let in the open market on a new lease commencing on that date.
- Stepped Rent – During the term the parties agree a predetermined upward stepped rent at agreed intervals. This approach is advantageous for the Landlord as it provides certainty and simplicity in calculating future rental income. However, it is also rigid as it takes no account of the increases or decreases in property valuations and market rents.
- Indexation based review –The parties agree that the rent will be reviewed in accordance with the increase/decrease of a pre- agreed index (e.g. Consumer Price Index). This index tracks changes in retail prices and alters the rent on review to reflect these changes.
- “Cap and Collar” Provisions – The parties may agree what is known as a “cap and collar” provision. A “cap” limits the amount by which the rent can be increased on a rent review and a “collar” stops the rent falling below a certain level. These provisions are becoming more widely used in recent times.
- Turnover Rent – the parties may link changes in rent payable to turnover. This is often used in retail leases where the rent is calculated by reference to the turnover generated by the Tenant with the rent payable often expressed as a percentage of this turnover. This approach provides the Tenant with greater flexibility and allows the Landlord to monitor the Tenant’s performance and take immediate action if performance drops. Similarly where a tenant trades above expectations, the Landlord is in a position to take advantage of this rather than waiting for a rent review. The disadvantages for the Landlord are the lack of certainty of the amount of rent payable and the reliance which the Landlord must place on the turnover information from the tenant.
- Shorter Term Lease – A shorter term commercial lease of less than 3 years may be agreed with a fixed annual rent and no rent review.
- Landlord Triggers Rent Review – It may be agreed that it is the Landlord’s option only to trigger the rent review i.e. even if the market rent has fallen, the Tenant is at the mercy of the Landlord as to whether a rent review takes place.
If the parties cannot come to agreement on the level of rent payable at the rent review the matter will normally be referred to a third party valuer such as a surveyor acting as either an Expert or an Arbitrator. The Arbitrator acts under the rules set out in the Arbitration Act 1976. The distinction between the two types of valuer is not so clearcut these days but as a general rule arbitration is a safer choice as the process is transparent and if the event of an error, you can apply to the court although it is often the more expensive option.
Is your rent calculated on the basis of a rate per square metre?
Sometimes, if you are about to lease a new premises that is being fitted out for you, it may be the case that your rent cannot be ascertained until the fitting out works are complete. As a result, the Lease may state that the rent will be determined on the basis of a formula to start after the “fitting out” period. The “fitting out” period is usually rent free.
Managing against the uncertainty of a market review
Many leases will include a market review upon exercise of an option to renew. The risk for you is that you exercise your option prior to the market review taking place – for example, if you are required to exercise your option to renew the lease six months before the end of the term, but your market review is not to happen until commencement of a further term. In such a scenario, you will have locked yourself into a Lease for a further term and subject to a rent that you did not anticipate paying, nor wish to pay. In this case the terms of the lease should include a provision that the amount of the market rent is to be determined and the period in which you must then exercise your option is varied so that the last day you must exercise your option is 21 days after the rent has been determined and notified to you in writing.
Does your Lease have an option to determine (“option to break”)
The lease may contain an option for either the parties, or just one of them, to end the Lease at a stated time or times or on the happening of stated events before the end of the term. A tenant may wish to ensure that the lease is drafted so that the option to break the lease can be exercised shortly after the rent review process is completed, whereas the landlord may prefer the rent review to take place after the right to break the lease has expired. To avoid unnecessary surprises when it eventually comes to reviewing the rent, both landlords and tenants need to ensure that they have a good understanding of the rent review provisions in their lease. For those about to enter into or grant a lease good quality legal advice should be sought. Informed negotiation on the terms of the rent review provisions can make a big difference to the amount the rent can increase by when the review finally takes place.