Rent Reviews: No More Up, Up, And Away!

Upwards-only rent reviews have been a key discussion within the real estate market over the past few weeks. Below are 10 Q&As on the upwards-only rent review topic which help to consolidate the current wider commentary; 

Why are upwards-only rent reviews a current talking point within the real estate market?

On Thursday 10 July, the Government released the draft English Devolution and Community Empowerment Bill (the “Bill”). Within the Bill, the Government set out a proposal to ban upwards only rent reviews in future and renewal leases. If the Bill becomes statutory law, an upwards-only rent review in a new or renewal lease will be unenforceable. 

What is an upwards-only rent review?

This is a clause in a lease which usually states something similar to “the new rent shall be the higher of the annual rent payable immediately before the relevant review date, or the open market rent at the relevant review date”. This means the reviewed rent, even where the market rent has gone down, will either stay the same or increase.

You may also see a minimum variation threshold as a percentage within the lease (also known as a collar).

What is the Government trying to achieve through the proposed ban on upwards-only rent reviews?

The Government claims the proposed Bill aims to create a fairer commercial leasing environment for tenants and, in turn, revive the high street. The Bill, however, doesn’t just cover shops in the high street; it covers all commercial leases, saved for those involving agricultural holdings, tenancies granted for six months or less and farm business tenancies. 

It should also be noted that the ban only applies to a “business tenancy” under the Landlord and Tenant 1954 Act (i.e. tenant is in occupation for the purpose of business). It is unclear if the ban will apply to a tenancy where the tenant is not in occupation, for example, a headlease where the head tenant has sublet the whole of the premises to an occupying tenant. 

Will all rent reviews in commercial leases be caught by the Bill? 

All rent reviews which prevent the reviewed rent from being lower than the pre-review level will be banned. This means that open market, index-linked and turnover rents, including a minimum base rent, will be caught by the Bill. 

If the ban is introduced in the current draft form and an upwards-only rent review clause is provided for in a new or renewal commercial lease, the requirement for rent not to decrease will be unenforceable; the new rent will be determined by whatever methodology is specified in the lease, for example in line with changes to the retail price index. The new rent may be higher, lower or the same as the pre-review rent. 

The Government guidance on the Bill provides that, in some circumstances, an index-linked cap and collar, where reasonable, might not be caught, but the level of detail and understanding around this is not yet known. 

Any agreement to avoid the ban, whether in the lease or another related document, will be void.

What impact will this have on tenants? 

This should provide greater flexibility for tenants and also provide an allowance for the rent to decrease during the term of the lease, which can make management of commercial leases easier during times of market recession. 

This may also result in shorter leases, which might be a positive for tenants, but this might be a negative if the tenant requires or has undertaken significant expensive fit-out works and the landlord will only agree to a shorter lease term.

The draft Bill also enables the tenant, where action is needed to trigger a rent review and the rent review terms do not allow the tenant to take the action, to initiate the rent review by written notice to the landlord. The same right will apply in relation to any “operational actions” necessary for the rent review process to operate. This will allow the tenant the ability to trigger the rent review if it feels the landlord is delaying in order to benefit from higher rental returns.

What impact will this have on Landlords? 

It will create uncertainty for Landlords in terms of yield predictions and valuations of their property. This may affect their financial stability and ability to secure loans. This will, in turn, affect investment in their current stock of properties. 

Landlords may grant shorter-term leases as a result of uncertainty and unknown impact on the market. A landlord will be able to request a stepped rent over the term of the lease, so they can be certain of the rental income from the property for the term of the lease, but this may cause artificial inflation of the rent over the term of the lease, so it is interesting that this is considered acceptable under the Bill. It would appear from the Government’s guidance notes that it is the clarity of the known rent which is the key factor in the Governments inclusion of this form of rent review. 

Will this affect my current commercial lease?

No, the Bill is only intended to apply to new or renewal leases (whether or not benefitting from security of tenure): it is not intended to apply retrospectively, nor will it apply to reversionary leases. If you have entered into a pre-commencement agreement before the date of enactment, the lease granted pursuant to this agreement will not be caught by the Bill.

However, ‘put options’, where the tenant can be required to take a new lease and the rent payable at the start of the lease cannot be determined when the put option is entered into, will be caught by the Bill and therefore subject to the ban.

Why is this potentially an issue for the wider investment market?

This could affect landlord’s property valuations and could see the approach taken by lenders to edge on the more cautious side as yields could reduce. 

If a landlord is not keen for a potential downward rent review to take place within the term of the lease, it may lead to shorter leases that avoid rent reviews entirely, or, in contrast, arrange for more frequent rent reviews in order to mitigate the impact of a potential downward rent review.

The post-covid lease reflects the changing commercial property market, especially in the retail sector, with shorter-term leases (as opposed to the more traditional longer-term investment lease) of 5 years or less (or if longer with break options). This increased flexibility, combined with short lease terms with no rent reviews, may in some sectors make the impact of the ban on upwards-only rent reviews less significant, but, nonetheless, it will alter the wider commercial letting market. Landlords, lenders and investors will need to factor in the effects of any ban on upwards-only rent reviews on property valuations, rental streams and investor confidence. We might see a significant change in future rent review clauses with index-linked reviews becoming more standard, or higher fixed or stepped rents at the lease start, so avoiding any mechanism for rent review.

Has this been tried and tested, and do we know if it will reinvigorate the high street?

Without any wider industry consultation on the draft Bill, or until more formal comment and industry body representations are made, it is difficult to assess the impact of the proposals on commercial leases and investment. 

Interestingly, we can look to Ireland, where upwards-only rent reviews were banned for new leases in 2010. The change did create some market uncertainty with shorter leases and a more cautious approach by landlords but has overall been considered largely successful since its inception. We should, however, err on the side of caution as Ireland’s property market does not have the same attractiveness as the current UK real estate market, so the impact may not be the same. 

What is the timing of the Bill coming into force?

The Bill is at a very early stage and was introduced without any consultation. It is already clear that industry bodies will want their views heard on the proposals, so it is difficult at this stage to know what the final position on the ban of upwards-only rent reviews will be. The British Property Federation criticised the proposals as “interference in long-established commercial leasing arrangements without any prior consultation or warning”. 

All interested parties should monitor the Bill’s progress and engage if or when the opportunity arises.