It is common for commercial leases with terms of over five years to contain a rent review clause. Rent review clauses allow a landlord to maintain the profitability of their investment by adjusting rent at given intervals by whatever mechanism is chosen for review. This blog will focus on the two most common mechanisms; open market rent review and index linked rent review.
Open Market Rent Review
An open market rent review clause provides for rent to be revalued in line with rents in the local market for leases of similar premises. The revised rental figure reflects what a tenant would expect to pay for the premises if it was re-let at the date of review. The majority of open market rent review clauses are “upwards only”. This means that the rent the tenant paid immediately before the review date is set as the minimum rent payable after the review so that rent can only ever stay the same or increase. This is because if rents in the local market have increased, the rent will increase; and if rents in the local market have decreased, the rent will not be reduced.
The revised rent using an open market rent review is usually determined by reference to a “hypothetical lease”. The rent review clause will detail the terms of this hypothetical lease in a series of assumptions and disregards about it.
It is important that the terms of the hypothetical lease reflect the actual position in the lease as far as possible, so it is recommended that legal advice be sought here. A party may suffer undue penalisation if the assumptions and disregards do not accurately reflect the circumstances of the current letting. For instance, tenants may wish to amend an assumption that the landlord has complied with its covenants under the lease in instances where the landlord has breached its covenants. This would prevent a situation where the tenant pays a rent based on the benefit of, for example, a state of repair that common parts aren’t actually in. Similarly, if a tenant has carried out and paid for voluntary improvements to the premises, it would be unfair to it if the hypothetical lease disregarded any increase in the rental value of the premises attributable to the works. The tenant would in effect pay twice over for the improvements: first for the improvements themselves, and second by way of an increased rent. For the sake of completeness, please note that the previous examples work vice versa.
Index Linked Rent Review
An index linked rent review clause provides for rent to be revalued by reference to a particular index. The practical benefit of this is that a figure can be determined without recourse to market analysis and surveyors, since the pre-determined formula can simply be input into a calculator. The most common indexes used are the Retail Prices Index and the Consumer Prices Index.
Although the Retail Prices Index is no longer an official UK statistic, it remains the most popular index in practice. This is likely due to the fact that the Retail Prices Index rises faster than the Consumer Prices Index – typically by around 1%. Further, the Retail Prices Index also offers Stamp Duty Land Tax benefits if rent review occurs within the first five years of a lease. The usual position is that Stamp Duty Land Tax is charged on any variation in rent attributable to an index linked rent review within the first five years of a lease. Variations in line with the Retail Prices Index are ignored however, as they are classified as an ‘excluded adjustment’ for Stamp Duty Land Tax purposes.
Landlords and tenants should be aware though, of the likely possibility of phased reform to the Retail Prices Index. From 2030, it is likely that the methodology behind the Retail Prices Index will be brought in line with the Consumer Prices Index or gradually phased out. Given this possibility, and in the interests of prudency, a well drafted rent review clause would provide for a substitute index in instances where the methodology behind the index is materially altered, or the index ceases to be published altogether.
The decision about whether to provide for open market rent review or index linked rent review is ultimately a commercial decision. When entering into leases containing rent reviews, regard should be had to the present and predicted nature of the rental market and to the levels of current and predicted inflation.
For specialist legal advice on commercial leases and rent reviews, please do not hesitate to contact Farleys’ commercial property team on 0845 287 0939 or contact us by email.