Hello and welcome to the third installment of the series. As promised, this time we will be covering ‘Rent Review’. As explained previously, this is a particularly complicated and misunderstood part of the lease and so we wanted to devote an entire article to it. It is certainly best to focus…
How to Read Your Lease
Clause 7: Rent Review
As set out above, the concept of Rent Review can be difficult for both Landlords and Tenants alike. However, if you start by considering it in broad terms then it more or less does what it says on the tin – i.e. you are simply arranging for rent to be reviewed at a specified time in order to account for any market fluctuations. The world changes, rateable values go up, and our high streets generally become more valuable. However, the opposite can occur but this will not be reflected in the rent collected by the Landlord. Rent Review is ultimately for the benefit of the Landlord as the rent WILL NEVER GO DOWN but it may stay the same. Every standard lease will provision for upward only rent review and so you can think of it as a Tenant’s worst nightmare and a Landlord’s daydream, albeit that the process and the calculation of the new rent can be convoluted and is not without argument (but rest assured – there is a clause for that).
When you are assessing your lease’s own rent review clauses you should always look out for any capitalised letters in the body of the clause as this will mean that the word or phrase is defined in Clause 1 of the lease (please refer back to module 1 of the series for more information). The defined terms will usually include: Rent Review Date – this will be the first date on which the rent will be reviewed followed by a provision that any subsequent rent reviews will take place every third or fifth (commonly) anniversary of this date. Rent Review Period is another one and this refers to the period of time in between the initial review date and the next review date.
There can even be a last-day rent review provision and this is so that the revised rent takes effect when a statutory renewal of the lease term, under the Landlord and Tenant Act 1954, has taken place.
Surveyor and President are usually defined within the body of the clause and are in general self-explanatory, but what you should note is that either a Surveyor will assist in determining the new rent or the parties can agree this between themselves. If the Surveyor is given this role then they are not just ascertaining what the new rent should be but can be seen as a check and balance system because rent review can cause conflict between the parties and the Surveyor is bound by the concept of ‘reasonableness’ (and not only that but the Surveyors decision is often made binding by the lease).
The Surveyor’s role in very general terms is to assess the market rents being paid on similar properties in similar areas of the country that are carrying out a similar business to that of the Tenant who is having their rent reviewed, subject to some matters we will come to in due course. This will create a type of ‘rent scale’ and it will be obvious what the best and worst possible rents currently being paid are in the chosen cross-section. If the lease does not specify that the rent on rent review must be the ‘best’ rent then acting reasonably a middle and potentially more reasonable rent would likely be negotiated.
However, if the lease does specify the ‘best’ rent requirement then the rent may be markedly higher than the current rent the Tenant is paying and the Tenant may construe this as being unfair or at least, less reasonable. There is generally quite a battle about the inclusion of the word ‘best’ in this clause for that reason and your arguments and ‘side’ changes according to who you are acting for.
So, when the Surveyor is determining the annual rent for which the property should be let he will assume certain matters in respect of the Property and disregard others…. Why is this? Because it levels the playing field between the Landlord and the Tenant (i.e. adds ‘reasonableness’) but this is on the terms set out in the lease and so realistically the terms assumed and disregarded could end up swaying the rent review more heavily in one of the party’s favour. This is likely to depend on their bargaining power. This concept may not make a huge amount of sense at this stage but please bear with me and keep in mind what we call the DEFAULT MENTALITY – that the Landlord wants to achieve the highest possible rent and so if he had his way then the matters assumed and disregarded would aid this and vice versa for the Tenant.
Let us take them in turn:
Assumptions: – these assumptions generally amount to things that will not diminish the value of the Property…
Now, just to be clear – we are giving you as much of a full picture as possible but this is simply a snapshot and we certainly have not covered every possible eventuality and so do not ‘assume’ that these are the only sub-clauses that you will ever see in a lease.
- Assume that there are no works that have been carried out that diminish the rental value – why would the Landlord want this? – because of our DEFAULT MENTALITY i.e. the Landlord wants what will generate the most money (because this is his business) and if the property is worth less at rent review because of some ‘suspect’ works then he will get less money. How do you improve the situation partially for the Tenant? By excluding works that are required by law brings both the local authority and statutory law – because, from the Tenant’s perspective why should they be penalised for something outside of their control.
- Similar to the provision above, it is assumed that if the Property has been destroyed or damaged that it has been reinstated or that the Property is in a state that is lawfully useable. This is because the Landlord would not want the potential rent available to be prejudiced by the damage and in many cases, the Tenant will benefit from a rent suspension and so it won’t affect them until the property is fit for occupation.
- Assume that both parties have fully complied with their obligations under the lease – the issues here are quite evident – what if the Tenant hasn’t complied with their obligations? Well, revert to the DEFAULT MENTALITY and think how that could affect the attainable rent. It is usually perceived as quite ‘fair’ to include this provision from the Landlord’s perspective- it’s not their fault that the Tenant has not complied.
- But what about the Tenant who is leasing one floor of a Building and the Landlord hasn’t maintained the exterior or roof of the Building as set out in the lease? I’m sure the Tenant would not want their rent increased on the assumption that the exterior and roof issues do not exist … but equally the Landlord would benefit from this assumption so he would want it to be included. You could argue that the Landlord should remedy the breach prior to or as soon as possible after the review and that as a result this should be assumed.
- The assumption that the Property is available to be let by a willing Landlord to a willing Tenant by one lease without a fine or premium being paid by either party and with vacant possession – this should be broken down into sections to explain it further. (1) the Property is available to be let by a willing Landlord to a willing Tenant – it may sound like unimportant sentence fluff but actually it is important to assume that on rent review the Property itself is marketable or this will adversely affect the potential rent achievable. However, even without writing it explicitly, there is precedent to say that this would be inferred. (2) by one lease – why is this important? Because of the potential for underleases of part that may affect the achievable rent. If it is specified that there is one lease only, this disregards the potential for these underleases of part. In the event of a dispute, the actual lease terms may be referred to and most often underleases of part are prohibited. (3) without a fine or premium – it would diminish the rent if for example, any incentive paid by the Landlord to new tenants was taken into account on rent review or if a capital sum has been paid for the lease by the Tenant (4) vacant possession – essentially the property is being treated as if there is no Tenant or as if the Property had never been occupied and as if there are no fixtures and fittings at the property currently. The lack of fixtures and fittings could have a negative impact on the potential value of the property and could have a knock-on inference that a tenant should have a free period to allow them to ‘fit out’ the Property. The Landlord would want it to be assumed that the Property is vacant but fitted out and ready to go. If not then our DEFAULT MENTALITY is affected. Tread carefully with this particular provision, it is surprisingly confusing and there has been a lot of case law that has not entirely successfully tried to deal with it. If you have any particular queries or concerns then Attwells are always happy to advise you.
- Assume that the Property may be used for any use within Class A1 of Part A of the Schedule to the Town and Country Planning (Use Classes) Order 1987 – Class A1 includes shops, retail warehouses, post offices, travel agencies, and more. This Class of Property usually achieves the highest rent on rent review and so is something that is sought out by Landlords. If the Property has a restricted use as Class A1 then there is no real issue for Tenants, but if they are using the Property for another purpose then this provision could be seen as unfair and certainly we have seen it argued as such.
Disregards – disregarding the effects to the Property caused by the Tenants occupation.
- Disregarding the Goodwill attached to the Property as a result of the business of the Tenant, Undertenant or predecessor – firstly, the Goodwill in a business is the reputation that the business has built up over time. Goodwill is considered an ‘asset’ and has an actual monetary value in itself. Therefore if the business is particularly profitable and well thought of then the asset is worth more. In turn, the profitability of the business could improve the general area in which the Property is situated. As such, this could increase the possible rent and the Landlord would not want this to be disregarded. However, from the Tenant’s perspective, is it fair that they pay a higher rent because they run a profitable business? The reason it includes ‘predecessor’ is that the business could have been taken over or bought by the current Tenant and the business could have been carried out for many years prior to the current lease.
- Disregarding any effect on rent attributable to any physical improvement to the Property and Service Media within or exclusively serving the Property carried out before or after the date of this lease, by or at the expense of the Tenant or any authorised undertenant with all necessary consents, approvals, and authorisations and not pursuant to an obligation to the Landlord- what could improvements do to the Property? It could increase or decrease its value. If it’s a positive improvement and you disregard the improvement to the Property entirely then this is great for the Tenant but perhaps over-generous from the Landlord’s perspective. Usually, it is seen as fairer for all parties to disregard the effect on rent but actually, we think this is a confusing sentiment and actually isn’t drastically different in terms of its effect as a provision excluding Property improvements.
This provision in general is for the benefit of the Tenant and so the Landlord would usually seek to minimise its effect of it as much as possible. The Landlord would therefore want to do two things: (1) add a degree of certainty by asserting that the specific improvements to be disregarded are those to which all consents, approvals, and authorisations have been granted, which minimises the potential number of improvements that are disregarded, and (2) disregards from these improvements any improvements made pursuant to an obligation to the Landlord – because the Landlord doesn’t want to shoot himself in the foot so to speak.
This covers the main disregards but is by no means an exhaustive overview.
We are aware that this article is particularly lengthy but we would like to highlight a few final points:
- Payment of the newly revised rent – this is a small point and maybe fairly obvious but it is best to mention it nonetheless. Until the new rent is determined the rent paid prior to the rent review should continue to be paid – the Tenant should not cease paying rent at any point. However, the Tenant is still responsible for any increased rent due from the Rent Review Date and so they will be required to pay the difference along with any accrued interest.
- How is the new rent recorded? – the respective parties will most likely want the new rent formalised in a document executed by the parties. This document is called a rent review memorandum and it sets out the newly agreed terms (and records the previous rent too)
- Stamp Duty Land Tax – this is rather convoluted and we would recommend dealing with a specialist accountant in respect of it. Attwells can recommend accountants that specialise in this area and so please do ask our advice. However, as a general point, you should note that if a rent review takes place within the five years then it means that the rent is seen for tax purposes as being ‘variable’ or ‘uncertain’. If rent increases within the first five years of the term then it will need to be recalculated and may result in further tax liability.
That draws our rent review overview to a close. It has been a particularly long article but we hope it has been an informative one. If you have any questions, please contact Nick Attwell on 01473 229242.
HOW TO READ YOUR LEASE MODULE 1: INTERPRETATION, GRANT, AND RIGHTS
HOW TO READ YOUR LEASE MODULE 2: THIRD-PARTY RIGHTS, ANNUAL RENT, AND INSURANCE