Rent Review – how does it work?

This article on Rent Review is the third in Herrington Carmichael’s series of articles explaining the importance and impact of specific clauses in commercial leases.

Commercial leases usually contain rent review provisions, which allows the rent reserved under a lease to change in line with the value of the property (the rental market).

There are a number of different ways for varying the rent under a lease, such as turn-over based rent, index-linked rent and stepped rent but the most common one we see is to increase the rent in line with the open market rental value.

Open market rent review:

The way this works is that the revised rent is based on the rent that would have been achieved if the property had been let on the open market on the rent review date, by a willing landlord to a willing tenant on the terms of a hypothetical lease.

Most often the rent review provisions are drafted so that the rent is reviewed on an upwards-only basis. This means that the rent will either increase or stay at the same level – it will never decrease. For example, if the tenant was paying an annual rent of £10,000 before the rent review date but following the rent review it transpires that the open market rental value is £8,000, then the tenant will continue to pay £10,000 per annum. If the open market rental value had been £12,000, then the new rent would be £12,000.

When dealing with a ‘hypothetical letting’ a surveyor will need to take into account “assumptions” and “disregards”. Assumptions are matters which we need to assume are correct or exist (when in fact they may not) – for example the parties have complied with all their obligations under a lease, when the reality may be different. Disregards are instructions to ignore a fact, even though it may be true. An example of this would be to ignore the rental impact of any alterations carried out by a tenant (as this could potentially have significantly increased the value, which would penalise a tenant who has already paid for the costs of the alterations).

Hypothetical Lease:

As explained above, the review will be based on a hypothetical letting. This means there will need to be a hypothetical lease.

The parties will be a willing landlord and a willing tenant. In the case o F R Evans (Leeds) V English Electric Company [1978] 1 EGLR 93 a number of principles were set out when establishing what a ‘willing landlord’ and ‘willing tenant’ are. The parties are not the actual landlord and tenant (specific attributes of the parties should be ignored), they are not real people or corporate entities).

The terms of the hypothetical lease will usually be the same as the real lease, save for some adjustments in respect of (for example) the rent, length of the term and break rights. There are other adjustments that can be made but these are not as common.

Time limits

It is important that parties check if there are any specific timeframes for when the rent review must have been carried out. A lease will usually contain a provision which states that “time is of the essence” or “time is not of the essence”.

Where time is of the essence, the timeframes are strict and where a party fails to serve a counternotice on the other party, it will have lost its right to renew or its right to dispute the proposed reviewed rent figure.

Where time is not of the essence there is no specific timeframe for when the landlord can impose a rent review, and it may do so even if the specified rent review date has passed. This means that it is important for a tenant to be aware that simply because the rent review date has passed does not mean the rent will not be reviewed.

What happens in the event that the parties cannot agree the new rent?

A rent review provision will usually deal with the appointment of an expert or arbitrator in the event the parties cannot agree on the new rent.

An expert will be able to determine the revised rent based on his own opinion but will often accept evidence from both parties.

An arbitrator will hold a judicial inquiry whereby evidence is provided by both parties and witnesses and the arbitrator will then make a decision based upon that evidence.

Either way, the lease usually states that the parties can jointly appoint an expert or arbitrator, or if agreement cannot be reached as to who to appoint then an application can be made by either party to the Royal Institution of Chartered Surveyors for the expert/arbitrator to be appointed by them.

Minimum and/or maximum increases?

The parties can agree that there shall be a minimum and/or maximum increase of the rent, to ensure there is some change in the rent payable under the lease but which provides some security to the tenant that any increase will not be too onerous.

Stamp Duty Land Tax

It is important for a tenant to understand that there may be Stamp Duty Land Tax payable to HMRC following a rent review if such review date falls within the first five years of the contractual term. Once the new rent is ascertained, depending on it’s level of increase the tenant may then need to submit a further return to HMRC and arrange for an additional SDLT payment to be made.

How can we help?

If you have any questions about rent review or would like further information as to the other types of rent reviews, then please do not hesitate to get in touch with the Real Estate team.

This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.