Rent reviews are a standard part of most commercial leases that landlords and tenants will have to deal with at some point during the contract.
How these clauses are structured can significantly affect financial planning and the long-term sustainability of your business.
It is important to understand the complexities of rent reviews to negotiate the most favourable terms possible. Through understanding how rent reviews work and what to expect in negotiations, you can protect your business from financial instability.
We break down what commercial rent review clauses are, the different types, the potential issues to be aware of, and why professional guidance is essential to securing favourable terms.
What Are Rent Review Clauses?
Rent reviews enable commercial property landlords to determine the amount of rent they charge their tenants. A rent review clause exists to allow landlords to adjust the rent on their commercial property, ensuring they maximise their returns on investment.
Typically, commercial rent reviews take place every three to five years. Most leases will specify when rent reviews occur. However, it is important to note that rent reviews can take place at any time the landlord and tenant agree.
The goal of a rent review is to ensure the rent keeps pace with the property’s value or broader economic shifts. For example, the landlord may want to increase the rent in line with inflation, the property’s current market value, and/or the tenant’s business performance.
Can the Landlord Increase the Rent?
Most commercial leases contain upward-only rent review clauses. This means that the rent can only increase, and will never decrease, even in worsening market conditions.
Understanding the landlord’s specific rent review formula is crucial for negotiation, as it will enable them to arrive at an agreement more effectively.
This structure benefits the landlord and can expose tenants to substantial hikes. This highlights the importance of negotiation and thoroughly reviewing the lease before signing.
The Different Types of Rent Review Clauses
There are several different rent review clauses. By understanding the four most common types, commercial property leaseholders can best evaluate what is suitable for their business.
Index-Linked Reviews
Index-linked reviews see rents increase in line with a form of index, commonly the Consumer Price Index (CPI) or the Retail Price Index (RPI). These reviews increase the rent by the same amount as the related index increased over the rent review period.
Index-linked reviews are predictable and transparent, as commercial leaseholders and landlords can both track the related index movements. This also makes it easy to calculate.
However, the indices may not account for local property market changes. For example, rent could be increased because the index rose, even if local market rates fell over that period of time.
Stepped Rent Reviews
If there is a stepped rent review clause, this means that the rent will increase by a fixed amount at agreed intervals with the landlord. For example, both parties could agree to a £500 annual increase.
This clause provides certainty and enables both parties to prepare effectively through budgeting. This could potentially be more favourable to either the leaseholder or the landlord. Leaseholders could pay below market value, or landlords could earn above the market value.
The inverse is also true, and this could be more negative for either party. The fixed increases may not align with inflation or market trends, potentially resulting in rent that is either too high or too low.
Turnover Rent Reviews
A portion of the rent is linked to the tenant’s turnover in this clause. This allows the landlord to benefit from the tenant’s business success, but they will usually agree to a lower base rate.
Rent adjusts based on business performance, providing flexibility for tenants. This can allow the leaseholder to operate their business with less pressure due to the lower base rate.
This approach will require significant provisions from the landlord to ensure that they do not miss any payments. Landlords will need to ensure that their tenants provide accurate financial disclosure and do not close for long periods of time. This form of clause can create a variable source of income for the landlord.
Open Market Rent Reviews
In this clause, rent is reviewed based on the current rental value of similar properties in the local market. The rent will be reviewed to match what the rent of a hypothetical lease would be for a new property in that area.
Open market rent reviews reflect real-time market conditions, offering leaseholders a degree of fairness in their rent increase.
These types of agreements typically require professional valuation advice to avoid lengthy disagreements between both parties.
Key Considerations to Take Note Of
Before signing a lease or approaching a review date, it is important to be aware of these particular elements:
- Review frequency: How often does the rent adjust?
- Review method: Is it index-linked, stepped, turnover-based, or market-based?
- Direction of review: Is it upward-only, or can the rent go both up and down?
- Notice periods and timelines: What’s the process and timeframe for initiating and completing a review?
- Resolving disputes: What happens if the landlord and tenant can’t agree? Consider the process for arbitration or independent valuation.
Always read the lease carefully and thoroughly. Hidden details in rent review clauses can have significant financial consequences, and a thorough review of the lease can help protect against these issues.
Why Surveyor Advice Matters
When navigating rent reviews, having a professional on hand may be the best way to prepare yourself. A chartered surveyor will provide a detailed understanding of both lease terms and property values, bringing valuable insight to the negotiations.
A RICS-accredited surveyor can interpret complex lease wording and ensure that valuations are fair and evidence-based, arming either party for a successful negotiation. Their expertise can prevent costly disputes and help commercial landlords and tenants alike reach an ideal outcome.
By involving a qualified chartered surveyor, you will ensure that you are well prepared for your commercial rent review.
Navigating Commercial Rent Review Clauses
Rent review clauses require considerable attention from both landlords and leaseholders for the potential impact that they can have on cash flow and financial stability. Whether you’re starting a new lease or have an upcoming review, it’s crucial to understand the structures and details to be well-prepared for negotiations.
When clearly defined and fairly negotiated, these clauses can protect both parties. But when overlooked or misunderstood, they can lead to disputes, unexpected costs, and financial stress.
Contact ASL’s RICS-registered team for a rent review consultation. The expertise and technical proficiency of chartered commercial building surveyors will offer substantial advantages to investors looking for an in-depth assessment of a property’s value and its condition.
The expertise and technical proficiency of our RICS Chartered Commercial Building Surveyors will offer substantial advantages to investors looking for an in-depth assessment of a property’s value and its condition.
