When two parties agree to enter into a commercial lease, usually for longer than 5 years, we would normally expect to see provisions in the lease for a review of the Rent.
A Rent Review is a way for a landlord to revisit the current rental value of a property after a number of years and adjust the rental payments in accordance with this. It is currently typical for a lease to have a rent review every three or five years, depending on the length of the term. The total value of a property can change substantially over time and if there were to be no review, a landlord would effectively be letting the property for a value below what the property is worth.
The three main types of rent review are;
This review is based on a “hypothetical lease” which starts on the review date. The “hypothetical lease” is normally a lease on the same terms as the lease itself, apart from rent and the length of the lease term. The review has a number of “assumptions” and “disregards” as part of the “hypothetical lease”.
An assumption in rent review is a direction that a certain fact or situation is assumed to exist for the purpose of valuing the property. It assists in “setting the scene” the terms of the “hypothetical lease” under which the rent is being reviewed. It can often make a significant difference on the rent payable. It is important to ensure the assumptions are clear to ensure that a dispute does not arise. The assumptions should be appropriate for the lease as the hypothetical situation produced after applying the assumptions could be so far removed from reality that it no longer resembles any actual properties so making it difficult for a valuer to value the hypothetical property.
Typical assumptions we see in lease drafting include:
As a landlord, there may be a requirement to add that the tenant is not disadvantaged by the potential or actual exercise of the option to tax. This stops any reduction in the possible rent by a tenant having to pay VAT and not being able to claim it back. As a tenant, this clause could put them at a disadvantage if they are a VAT-exempt business. Ideally the tenant would request this is excluded if the assumption does not reflect reality.
In recent years, a landlord now needs to consider whether any environmental considerations need to be included as an assumption. The minimum energy efficiency standards can often catch a landlord in a trap if the property has a worsened EPC rating due to works undertaken by the tenant. A landlord would want to include within the assumption that the Property has a particular EPC rating (at least the rating it was let with) or an assumption that the property can be “lawfully let”. The reason for this is that if the property has an EPC rating of ‘F’ or ‘G’ it cannot be let out. Read more on that here.
In the same way as assumptions are used to set out assumed facts and situations of the letting, disregards are a direction that a certain fact or circumstance is to be ignored when deciding the rental value of the property. These disregards assist in ensuring that that “hypothetical lease” bears resemblance to the real life situation and so a more accurate valuation can be achieved for the property. Disregards are generally intended to ensure that the “hypothetical lease” is fair on both parties as far as it can be (for example, removing the effect on the rent due to physical improvement works completed by the tenant ensures that the tenant does not pay rent on works they have carried out at their cost for the purpose of carrying out their business).
As discussed above, there is a new concern for landlord of the effect of minimum energy efficiency standards. As such, one point the landlord now needs to consider is whether they wish to disregard any works undertaken by the tenant which has resulted in a lower EPC rating.
Typical disregards which are seen in the drafting of a rent review are:
If the landlord and tenant cannot agree on a revised annual rent, the lease should ensure provisions are in place for a third party to determine the rent. This is an independent person who will usually act as an “expert” and whose determination is to be conclusive. A third party is appointed to determine the rent to ensure there is not a stalemate during the rent review process where both parties believe a different figure should be agreed and so no agreement can be achieved. The third party steps in under the provisions set out in the lease to make an expert determination on what the property could be expected to achieve on the open market.
Ambiguity in a rent review can cause serious problems. Both parties need to be clear from the start on what the requirements are for the rent review. Any ambiguity can lead a court to take presumptions from reality. They will look at what is happening under the current lease as this reflects the reality of the current set up. Any ambiguity in drafting will push the court to find in favour of the tenant. Making sure the rent review provisions in your lease are drafted clearly before you sign is vital to ensuring the rent is reviewed in line with your requirements. We can prepare and negotiate the terms of the lease to ensure that any requirement you have as part of the rent review is set out clearly in the drafting.