When negotiating the terms of your lease for commercial premises, agreeing the rent payable will be a prime concern, but so too should be the prospect of agreeing the rent review provisions, even though this may be a long way off.
Angela Robinson, a commercial property solicitor at Warners, outlines the implications and different ways of structuring rent review provisions in a commercial lease.
Why is the annual rent to be reviewed?
A landlord will require the annual rent to be reviewed regularly in order to ensure that the rent they receive is not less than the current market value. In a lease with a term of, for example, 10 years it is usual for the landlord to require a rent review at the end of year five. Where the lease is granted for a shorter term, for example less than three years, it is less common for the rent to be reviewed.
That is not to say that with higher-value properties, or where the market conditions are unstable, rent reviews cannot be introduced in shorter-term leases. This will be a matter of negotiation and will depend on the relative bargaining power of each party and the market conditions when the lease terms are agreed.
For example, during the recession, the market was generally more favourable to tenants, as landlords wanted to keep them in situ. It was easier for a tenant to negotiate either a better rent review provision or to tie it in with a break clause. This enabled the tenant to end the lease if the revised rent was not acceptable to them.
In a more buoyant market however, a landlord may be able to insist on more regular rent reviews; this could be every three to five years. In a longer-term lease, five-year rent reviews are still generally considered to be the norm.
How is the rent reviewed?
There are different ways in which rent can be reviewed:
- Market rent review – the most common method is for the rent to be reviewed based on the market value at the time of the review and the usual position is for the review to be the higher of either the market rent or the current rent. This means that in a falling market, whilst the rental value of the property may be less than the existing rent currently payable a tenant would continue to pay the existing rent, until the next review date
- Retail prices index rent review – rent is increased (but not decreased) in accordance with inflation. This type of review may be more suited to lower-value or shorter-term leases
- Fixed rent increase – this is useful where both parties require the assurance of knowing what the rent will be throughout the term of the lease to assist with cash flow and budgeting. This is more likely to be agreed in a stable market
There are other ways of reviewing the annual rent and it is therefore recommended that advice is taken at an early stage, ideally before heads of terms are agreed. This will ensure that the provisions for rent review reflect market conditions.
Who reviews the rent?
The usual lease provision will be for the tenant and the landlord each to instruct a valuer to assess and agree the revised rent in accordance with the valuation criteria set out in the lease. In the event the rent cannot be agreed in this way, the lease usually provides for the rent to be determined either by an arbitrator or an expert.
Once the rent is agreed, it should be recorded in a memorandum which is attached to the lease and signed by both parties and their respective valuers.
Any increase in the rent will usually be paid by the tenant when the next rent instalment is payable.
If the rent is not agreed until after the review date it is usual for the lease to provide for the payment of interest on the agreed increase. This prevents the tenant from delaying the agreement of the rent review.
What are the implications of a rent review?
A rent review will not amount to a variation of the lease, unless the lease does not provide for a rent review.
It can, however, have implications for the tenant in terms of Stamp Duty Land Tax (SDLT). If the increased rent means that the SDLT liability for the term of the lease is increased, the tenant will be obliged to make a further payment to HMRC at the time of the rent review.
As mentioned above, it is also common for break clauses to be linked to rent review dates giving the tenant the ability to end the lease if they are unhappy with the outcome of the rent review.
Careful consideration needs to be given when agreeing rent review provisions, in order to take account of a break clause and from a landlords point of view to ensure that the review allows for an upwards review only. Consideration must also be given to ensure that the provisions would reflect a change in circumstances or a variation to the terms of the lease. For example, if the use of the premises changes, the rent review provisions need to be adequate to deal with any effect in the rental value resulting from the change of use. Further, any works carried out to the premises by the tenant during the term of the lease may increase the rental value. A tenant who has carried out works at its own expense does not want these to be taken into account when valuing the premises on rent review.
There are many things to consider in agreeing to a rent review and professional advice should be taken as early as possible to avoid any issues once the lease has been entered into.
The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.