People can be surprised by how the rent under a lease on commercial property can change over time. And to make matters worse - well, for a tenant that is - often only going upwards and not downwards.
Therefore, it’s critical to get to grips with these rent review clauses within any business lease for commercial property. If not, you may well pay the price.
You see, the driving force with more commercial properties is long term investment value. So having that steady rent over a long period, and historically what they call on an ‘upwards only’ basis, provides good solid investment value.
Residential property tends to be focused on more turnover of short-term lets at whatever the current rental level is at the time, or selling off with longer-term value; therefore, it is less common to see such rent-review clauses here, however, still possible.
The Seven Rent-Review Secrets
Without getting bogged down with all the technical legal talk of leases, here are seven of the essential factors to consider. These provide a good overview of the whole process from start to finish to first get you seeing the bigger picture:
1. Types of Rent Review
Straight off the bat, check the lease to see the exact nature of the rent review. These clauses can get technical, and you ideally need professional help to get it right.
The popular one is on an ‘open market value basis, and ‘upwards only’ (more on this in the next point).
Watch out for others, though, for example, the rent based upon some kind of turnover if, say, a retail store or a fixed-calculations may be based upon the rate of inflation or RPI index. Although these are simpler in principle, the detail can get cumbersome, right down to applying the correct figures and months in the calculations.
Also, be clear on how often the rent reviews kick in, usually a lot longer than you expect, typically every three or five years.
2. The Open Market Basis
This is the popular form of rent review and is worth a separate mention, basically stating that the rent should be at the open-market level.
At face value, this all makes sense, of course, whatever the going rate is. However, this should naturally take account of a tenant’s ability to make a reasonable profit and yet afford the rent and other outgoings.
However, two words of warning here. Firstly, the total rent is often made up of a detailed calculation, often on a standard rate per square foot or meter or space with appropriate adjustments.
For example, if you rent your house, you tend to see what similar properties are going for and make a sensible adjustment, whereas here, there’s a bit more science.
And secondly, the lease often explains a hypothetical situation that you have to assume when looking at the rents, which isn’t necessarily reality. So, for example, an empty property with no fit-out, ‘willing’ landlords and tenants in the market, and ignoring the goodwill of the tenant’s business in question.
3. Notices & Procedures
As you get on with agreeing on the new rent, the lease will often say that specific notices by certain parties in certain time frames must be adhered to.
This often begins many months before a rent review takes effect but allows for time to progress afterwards, as often you need that valuation date to be historical to look at what the rent is for that point in time.
If these are missed in terms of dates or even effective receipt of notices by the other side, then you can get into all kinds of disputes as to what can still be completed, with time being ‘of the essence’.
4. Negotiating the Rents
Time then to brush up on negotiation skills, as no matter what the lease states, there is often an area of interpretation that a landlord and tenant will tend to steer in their favour.
So, rent fees quoted may be deliberately high or low to get the ball rolling and counter-proposals entirely at the other end of the scale. This can lead to detailed discussions regarding what actual comparable rents are being considered and ways of applying these, even amongst seasoned surveyors and valuers.
During these talks, you can often refer to other asset management opportunities simultaneously. So whilst talking about new rents, then maybe a forthcoming lease renewal can be looked at as well, or even a ‘re-geared’ lease where you decide to basically end the current one early and take out another longer one now.
And part-and-parcel of this is rent inducements to the overall headline rent, for example, rent-free periods or premiums being paid.
5. Independent Help
If you come to loggerheads with the other side as to what this new rental level should be, then don’t panic; there’s usually the opportunity to seek an independent third-party’s decision on things.
Often this is through someone acting as an Arbitrator or Independent Expert as determined between the parties or an independent redress scheme like the RICS.
The main point to bear in mind is that this can be timely and costly if implemented, with various submissions and reports being needed.
And these costs must be picked up by either the landlord or tenant or both, as determined by the lease or third party’s determination.
In reality, it’s more a bargaining point and the threat of taking the matter to third-party determination if the other side isn’t playing ball.
6. Documenting the Result
When you have the rent finally decided, this is usually formally documented on a piece of paper known as a Memorandum that both the landlord and tenant agree to.
Solicitors may need to draft this; however, it can be formed directly with care so long as the information, dates and figures on it are correct, and original copies are held in the records of both the landlord and tenant.
As an aside, when looking through any existing leases and situations, check that previous rent reviews have all been agreed, even if no change to the rent, to ensure nothing comes back up out of the woodwork.
7. Dealing With Consequences
The final point to remember is that there is often a financial cost to this new rent, not only the new level being budgeted for going forward and any fees being paid.
This is where the effective date of the rent review is historic and seeing an increase because most commercial property leases will permit the landlord to be paid back-rent due from this period tomorrow. Just make sure you apportion this the correct way, with most commercial leases stating that rent is paid quarterly in advance.
Plus, additional interest on this back rent, often at a certain percentage above a base rate.
Resolving Rent Reviews
Whatever interest you have in commercial property, it’s essential to understand the basis of rent reviews in all leases. If you’re a tenant, you’ll want these to reduce your overheads, if a landlord to increase to enhance investment value, or a middle-man advisor to provide the correct advice and service.
Once you apply these seven principles to your situation, you know what detail needs to be delved into. You’ll then probably need some legal or surveying help to get to grips with how this correctly relates to you in reality, but all within a framework that now makes sense.