Pre-2008 standard rent review position
Traditionally, a lengthy rent review clause was inserted into the lease - to govern the way in which the new, revised, rent was to be agreed between the landlord and the tenant. Such clauses were generally broken down into three main sections:-
- Firstly the mechanism for actually initiating the review - this dealt with such issues as which party can trigger a review of the rent, how they actually go about doing this and what the consequences might be if these steps are not followed correctly.
- Secondly, the basis upon which the revised rent will be calculated had to be set - this is never easy to explain in a short paragraph, but generally a hypothetical letting is established which simulates a real market situation and provides the basis on which a valuer is able to calculate an open market rental that should apply to the particular property. This hypothetical letting is usually on the basis of the actual lease terms but makes a number of assumptions, most notably that the letting is between willing parties on the open market with vacant possession and that both parties have complied with all the lease terms. In turn, other matters are disregarded, usually any improvements carried out by the tenant to the property and any goodwill that they have generated while in occupation - for the reason that tenants should not be penalised by having to pay a higher rent due to favourable circumstances which they themselves have created. Once this hypothetical model has been created, the idea is then that a valuer can look at the model and provide a professional assessment of the open market rent. Then the new rent would be the higher of the current rent and that assessment of the open market rent - ie the reviews were always "upwards only".
- Thirdly, there are the ancillary clauses that deal with more of the practical aspects - including some form of dispute resolution mechanism, usually by referral to an independent surveyor. Provision will also be made for the levels of interest to run on any backlog of rent paid at the "old" levels pending the review being completed and also the method for recording the new rent once it is agreed.
A rent review clause such as this can run to many pages and indeed often demands its own separate schedule in a lease. It is of little surprise that a deluge of rent review cases found their way to the courts as eager lawyers picked their way through increasingly complex wording. In recent years however, this has become more of a trickle and it would be fair to say that as the new century matured, a fairly settled and accepted standard set of criteria had been established to govern open market rent review determination.
Shorter duration leases and the possibility of downwards reviews?
Then of course, the economic downturn happened and this had a number of consequences for the rent review market and the hypothetical rent review model.
Landlords were often finding themselves having to accept nil uplifts in rent which, on say a five yearly rent review cycle, meant that they were potentially looking at a ten year period with a stagnant rent. They were at least able to rely on the accepted rent review practice that any revised rent would be upwards only so could not decrease, but this in turn meant that tenants could find themselves in a position where they were paying over the market rate for rent.
As an aside it is interesting to note that the 2007 Code for Leasing Business Premises that has been adopted in England and Wales (although it is still voluntary) specifically recommends that downward rent reviews (subject to minimum of the rent payable at the start of the lease) are offered to a tenant. At present there seems to be no movement at all towards this in Scotland.
The downturn was also one of the drivers that saw a reduction in lease lengths. The British Property Federation estimated recently that the average length of a commercial lease is now around 6 years. With rent review cycles traditionally being 5 yearly, a shorter lease can mean that a rent review clause is unnecessary.
Alternative rent review methods
Clearly some parties will still be entering into longer leases, perhaps with break options - so a review of the rent would remain appropriate. However, there has been a definite movement away from the hypothetical rent review model and towards other, more certain, methods of rent determination. These can be very straightforward, for example the precise rent for each year of the lease can be stated at the outset (this being known as a "stepped rent") or can be quite sophisticated, linking rent increases to RPI possibly supplemented by references to compounded interest and minimum and maximum percentage annual increases.
The main reasons for the adoption of such alternative rent review models are:-
- both parties' desire for certainty in times of economic upheaval
- such methods are cheaper to operate and
- tenants' stronger negotiating positions have forced landlords to accept something that they might previously have dismissed.
The British Chambers of Commerce last week reported projections indicating that economic growth in the U.K. will beat its pre-recession peak in the second half of next year, which can only be good news for the commercial property market. Whether this is sufficient to breathe new life into the open market rent review clause remains to be seen; but if the sight of a traditional rent review clause being pronounced dead and then resurrecting itself isn't enough to jolt Miss Marple into action from her St Mary Mead parlour, then nothing will.