Alternative Rent Reviews
Most commercial leases of reasonable length include provisions allowing the rent to change over time to ensure that the landlord receives a rent that reflects the true value of the property. A typical rent review clause allows one or both parties to trigger the rent review at a particular point. The interval between rent reviews has varied but 5 years has generally been the norm. Usually it is open to the parties to the lease to agree the new level of rent, with the option to refer the assessment to an independent third party if agreement cannot be reached. The lease will usually set out provisions about how the level of the new rent is to be decided.
In recent times, average lease terms have shortened considerably so that many leases of 5 years or less will contain no rent review provisions at all but for those leases of terms exceeding 5 years, the practice of including rent review provisions has remained.
Traditionally most rent review clauses have been upwards only to protect landlords from falls in rental value, but this has been under attack from tenants and meanwhile the Code for Leasing Business Premises has encouraged the use of flexible alternatives and pricing structures. The open market rent assessment remains the standard but what are the alternatives?
The most common are:
- Indexation
- Stepped increases
- Turnover
1. Indexation
Here, rent is linked to an index, frequently this is the retail prices index but sometimes other indexes are used such as the consumer prices index or one related to building costs. The index tracks changes in prices and alters the rent in the way that reflects the changes in the index. Of course, linking rent to an index may not be the best way to judge rental values but the great advantage is that it is quick easy and cheap and an RPI review also has the advantage that it does not trigger any further SDLT liabilities.
2. Stepped increases
At the outset, the lease contains set increases at particular dates. This has the great advantage of certainty and simplicity but the other side of the coin is its rigidity and it takes no account of any increase or decrease in property values.
3. Turnover
This is where rent is usually based to some degree on the tenant’s turnover at the property often expressed as a percentage of that turnover. Alternatively, it can sometimes be based on profit or production generated at the premises. Often there is a basic rent payable and turnover rent is paid in addition, ensuring that the landlord avoids the situation where no rent is payable at all if no income is being generated from the premises. Turnover rents are more common in the retail and leisure sectors and can sometimes be used where a tenant is unsure of the possible success of a new venture and the landlord is persuaded to accept a lower basic rent in the hope of a higher share of profit.
While we do now see more alternative mechanisms, open market rent reviews remain dominant. This sets us apart from Europe where the use of index linked reviews are common place. In the UK, landlords seem unwilling to risk the situation in a longer lease of rent falling behind the market value. However, some landlords and tenants do recognise the simplicity of index linked reviews and they are also seen as useful for new property or property that is difficult to value through lack of comparables.
If the UK is to move more towards the European model then there is a long way to go. However, in the current market, the combination of shorter lease terms and the prevalence of break clauses means that rent review provisions either do not feature in the lease to begin with or are less relevant.
This article contains information of general interest about current legal issues. It does not give legal advice and specific advice should always be sought about your particular circumstances. We will be happy to assist.
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