Rent review clauses are commonplace in today’s commercial market, but why? This blog will address the different rent review mechanisms and essential considerations when entering into a lease.
Rent review clauses set intervals during a lease at which the rent can be reviewed and changed to reflect the ever-evolving economic environment. This essential function can ensure that the amount of rent paid under the lease remains commercially competitive. When granting or entering into a long-term lease, a well drafted rent review clause is imperative in order to protect both the tenant and landlord’s future interests; a lot can change over the course of 25 years.
A well drafted lease will provide for an “upwards only” rent review. This means that the rent may increase at the relevant review date to reflect a strong economic environment or remain static. The rent cannot, however, decrease to reflect a downturn in the market. A clause drafted in this way can prove vital in protecting a landlord’s income.
Rent reviews are intended to keep the rent commercially fair in an unpredictable and ever-changing economic environment, but how is this achieved? What are the objective mechanisms used and essential considerations?
The most commonly used form of rent review is open market value. In this model, the rent is set in accordance with open market conditions at the time of the review. This is done by comparing rents charged on similar properties in similar areas.
In order to maintain objectivity when assessing the rent payable, parties often agree to engage a surveyor. While negotiations may be required, resulting in delays and additional expenses, the landlord and tenant will gain knowledge of the true open market value of the property and the appropriate rent amount.
In fixed rent reviews, the tenant and landlord decide the increase of rent at the outset when negotiating the lease. A fixed increase provides certainty as both parties know what the increase will be and when it will occur. The trade-off for this certainty is a lack of flexibility and the risk that the agreed increase, while fair and equitable at the outset of the lease, no longer reflects the economic climate at the time of the review. This risk has made fixed rent reviews less attractive, especially following the most recent financial crisis and recession.
For this reason, open market value reviews are generally favoured over fixed reviews as they can respond to a fluctuating rental market.
Inflation indices are often viewed as a reliable measure of the economic environment. Linking the rent review to one of these indices can provide a fair and equitable way of reviewing the rent to reflect the true economic position. While any inflation index can be selected by the parties, the 'Retail Prices Index' (RPI) is most commonly used. In some cases, minimum and/or maximum increases to the rent may be provided for. The former protects the landlord by ensuring the rent remains in line with inflation. The latter protects the tenant from high inflationary increases.
As an arithmetical formula is used to calculate the increases, it is essential that the formula be checked, preferably through a worked example, to ensure it provides the outcome intended by both parties.
A turnover lease is often found in the retail sector and provides an alternative to a traditional rent review. This lease can be used as a means of sharing the risks and successes of a commercially trading tenant as the rent payable is either wholly or partially determined by the turnover achieved by the tenant. Where a tenant trades above expectations, the landlord benefits immediately rather than waiting for the rent review. In circumstances where the landlord refurbishes a retail development and that investment is reflected in an increase of trade and higher turnover, the landlord will, again, be able to benefit immediately.
At Murray Beith Murray, we have extensive experience in drafting and revising rent review clauses when preparing commercial leases. If you are considering renting your commercial property, are about to enter into a commercial lease, or have any queries regarding rent reviews, please get in touch with us on 0131 225 1200 to speak to one of our dedicated team of highly experienced Commercial Property Lawyers , or complete our online Contact Form, and we will be delighted to assist you.