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Intervals for reviewing the rent of a lease
Most medium to long term commercial leases contain provisions to allow the rent to be reviewed at intervals throughout the term of the lease. This is particularly important in longer leases, as it normally allows the landlord to renegotiate rent to ensure that they receive rental income that reflects the true market rental for the property. Often, the rent review will be linked to the rent the landlord could achieve if let on the open market or a rent increase will be based on the increase in the retail index price (RPI) or some other index at the time of review. In commercial leases, it is very common for the rent review to be “upward-only”, meaning that the rent payable after review will not be less than the rent payable before review.
Upward-only rent reviews are advantageous to landlords as it protects their income and preserves the capital value of the lease. Landlords have the luxury of knowing that, even if the market dips, the rent they receive will not decrease. However, such reviews are often interpreted as unfair, as it can cause tenants to over-pay and offers little flexibility for dramatic shifts in the market.
Commercial Rent (Prohibition of Upward-Only Reviews) Bill
In June 2021, a liberal democrat MP put forward the Commercial Rent (Prohibition of Upward-Only Reviews) Bill, which is currently in its second reading of Parliament. This Bill not only seeks to prohibit the use of upward-only rent review clauses in commercial leases going forward but also seeks to retrospectively invalidate any such existing clauses.
For landlords, this would limit their power to protect commercial rent from falls in the open market and it removes the certainty regarding the minimum rent they can expect to receive throughout the term. It would also undo rent review provisions agreed upon after open and informed negotiations between parties in existing leases. For tenants, it has the obvious advantage of protecting them from over-paying and creates greater fairness between the landlord and the tenant.
In light of the Bill, landlords may start to consider an alternative form of rent reviews, such as stepped rent or turnover rent.
What is Stepped Rent?
Stepped rent involves the lease stipulating at the outset stepped increases in rent throughout the term. This has the benefit to both parties of providing clarity on the rent throughout the term of the lease. However, it limits the flexibility for the parties to renegotiate rent based on external factors such as open market rent or the tenant’s turnover, and both landlords and tenants take the risk of whether the stepped increases will represent a fair rent throughout the term.
What is Turnover Rent?
Turnover rent is usually based on the turnover or profit generated by the tenant at the property. Often, the landlord and tenant will agree a basic rent which will be payable alongside the turnover rent. This arrangement is advantageous to tenants as it ensures that their rent is reflective of the income they are generating. Landlords do incur a risk that their income will reduce if the tenant’s business suffers, but they could also enjoy a high rental income should the tenant’s business thrive.
The Commercial Rent (Prohibition of Upward-Only Reviews) Bill is likely to have been triggered by the impact of the Covid-19 Pandemic and follows other legislation favourable to tenants, such as the suspension of landlords’ ability to exercise the right to forfeiture. Although the Bill is very much in its preliminary stages, its potential impact would be wide-ranging and commercial landlords, and tenants are likely to be closely monitoring its progress.
Here to help
If you have any more questions or would like more information regarding the commercial rent bill, you can contact our Commercial Property Team below.