Before entering into a commercial lease, the Landlord will give some thought as to how much rent they will want to charge the Tenant. A commercial lease can range from a few months to many years in length. The length of term will largely navigate whether the Landlord will want to include provisions in the lease to allow them to increase the initial level of rent.
In this article we will discuss what a rent review is, what to look out for in a rent review clause, when they take effect and what happens if the parties do not agree to the rent review.
What is a rent review clause?
A rent review clause allows for periodic adjustments of the rent, taking effect on specified dates throughout the lease term, typically every three or five years in leases longer than seven years. These clauses often permit both the Landlord and the Tenant to initiate the review, but usually only allow the rent to stay the same or increase, not decrease. The clause sets out when each review will take place and how it will be assessed.
What is a rent review
A rent review is a clause in a commercial lease designed to address the balance between a Tenant seeking a long lease term and a Landlord wanting the ability to adjust the initial rent, particularly during periods of inflation or a rapidly changing property market. Landlords are typically unwilling to commit to a fixed rent for the entire term, so it is important that the heads of terms clearly set out the initial rent, how often the rent will be reviewed, and the mechanism used. This mechanism is crucial, as Tenants must consider the potential for future rent increases and whether they will remain affordable.
Commercial rents are usually paid quarterly in advance on the usual quarter days, 25th December, 25th March, 24th June, and 29th September, or on other dates specified in the lease. This is particularly significant where break rights apply, as it must be clear whether the Tenant is required to pay the full rent for the quarter in which the break occurs or a proportionate amount. Break rights and rent review dates are often aligned to allow flexibility in the event that a proposed rent increase is not agreed or is unaffordable.
What determines a rent review?
When it comes to reviewing the rent, a number of key factors will be considered to ensure the revised figure reflects current rental values. These include the state of the market, the property itself, the lease terms, and how much time is left on the lease.
Market conditions: If the review of the rent is to be based on the market rates, the valuer will compare the passing rent for similar properties in a specific area. The valuation should align with rental value. Of course, depending on how the market conditions are at the time of review, it may be considerably different to how the market was behaving at the beginning of the lease term and so the review could be higher than the initial rent paid, or lower, in extremely rare cases.
Property characteristics: When undertaking a review of the property for assessing the rental review, the physical aspects will be taken into consideration such as the size and the location. Clearly, a prime location or newly renovated properties will likely attract a higher rent than those properties in need of repair and in a less popular area.
Lease terms: The lease terms will be reviewed alongside the passing rent by the valuer, such as what the property is being used for, whether the use is restricted, or whether the property could have wider use in which case, this would invariably influence the rent review.
Length of lease: When the lease was negotiated at the outset, the parties would agree how frequently the rent is to be reviewed throughout the term. The longer the lease term left, the more frequent rent reviews and potentially more significant increases when they occur, rather than for shorter leases.
The commercial rent review process
The most common approach to a rent review is based on the open market. This assesses the rental increase by reference to the market rent for comparable properties at the review date. These rent reviews generally take place at 3 or 5 year (regular) intervals and are usually upwards only to the higher of the passing rent and the market rent at the review date.
The rent review clause requests the parties or a valuer, if appointed, to determine the rent if the parties cannot agree, to assume a new ‘hypothetical’ lease of the property granted on the relevant review date by a willing landlord to a willing tenant. The starting point for valuation of the market rent for the hypothetical lease will be the actual premises and the terms of the existing lease, but the valuer will be required to make various assumptions (for instance, that the property is in good repair) and to disregard some matters (such as improvements made by the Tenant).
1. Notice about rent review
Before a rent review date comes around, either the Landlord or their agent will notify the Tenant of the upcoming rent review. This is done typically by Notice and includes the date of the review and the basis for the review in conjunction with the provisions in the lease.
2. Rent review assessment
In the case of a market based review, both Landlords and Tenants gather information about the current market rental value of similar properties in the area based on similar square footage. This may involve engaging independent valuers of surveyors to assess the property’s current market value.
3. Service notice
The Landlord or Landlord’s agent will serve the Notice on the Tenant at the address of the Tenant’s premises in the Lease, setting out the new rental figure to be charged due on the review date for the next quarter and if agreement is reached, the new rent is formalised by the Landlord’s solicitor by way of recording the new rent in a Rent Review Memorandum. This is an important document recording the agreement reached between the parties and should be kept with the Lease. If the parties cannot reach agreement, then the Lease will contain provisions dealing with disputes such as arbitration or mediation.
4. Agreement on new rent
If the Tenant or their agent reaches a different rent review figure to that of the Landlord’s proposed figure, then the Tenant must serve a counter Notice on the Landlord in enough time for both parties to agree to the new rent.
While the parties agree on the new rent review figure, they must adhere to the timeframe referred to in the Lease. The Lease may, for instance, refer to “time is of the essence” to agree and implement the revised rent. Failure to comply with the provisions of the clause could result in the loss of opportunity by both parties to review the rent or dispute a proposed review.
5. Documentation
Once the new rent has been agreed between the parties, a Rent Review Memorandum will be drafted by the Landlord’s solicitor, recording the agreed rent after the review, ensuring that both Landlord and Tenant are legally bound by the revised terms. It is a formal written document signed by both parties, outlining the new rent, its effective date and any other relevant details. Implementing a Rent Review Memorandum avoids future disputes arising.
What if there is a disagreement about the rent review increase?
If the parties cannot reach a compromise then they will need to rely upon the terms of the Lease which deals with disputes. It is usual for an independent surveyor to be appointed rather than using their own agents to assess the fair market rent. If this is not provided for or the parties still cannot reach agreement, there will usually be arbitration and mediation referred to in the Lease as alternative dispute resolution methods. Mediation is a negotiation process facilitated by a neutral third party, aiming to reach a mutually agreed settlement, while arbitration involves a neutral third party, usual an arbitrator, to make a binding decision on the rental figure.
How can Goughs help?
Goughs commercial property solicitors are experts in all areas of commercial leases whether this relates to drafting, negotiation, surrender, post completion formalities and anything in between. Whether you are a Landlord or Tenant and are in need of assistance to navigate your rent review, we can help you. We cut through the jargon to explain things in everyday language to ensure that you are comfortable in your understanding of next steps and general processes. We believe that communication is key and our friendly, responsive team will always be at hand to help you every step of the way.
