Commercial Property Rent Reviews

Commercial Property Rent Reviews: Maintaining Asset Values

This article looks at some of the key concerns in connection with rent reviews for each party to a Lease.

Commercial property Leases with a longer term (e.g. one for more than three to five years) will usually contain a rent review provision to allow the rent to “keep up” with the changing rental values.

Rent reviews are crucial for the Landlord to maintain the value of its investment, enabling it to benefit from any increases in rental values over the term of the Lease. Without them, investor Landlords would struggle to sell or fund property.

Types of rent review and alternatives to rent review:

There are different methods of carrying out rent reviews. However, almost all rent review clauses include a formula or method by reference to which to calculate future rent at a particular date (a review date). Examples are:

Open market rent review: Here the rent is reviewed by reference to the market rent for comparable properties at the review date.

Index-linked rent review: Here the rent is linked to a particular index (such as the Retail Prices Index or Consumer Prices Index) at the review date. These types of clauses may be regarded as appropriate where the Tenant is in a strong negotiating position, the view sometimes being that an indexed review is likely to produce a lower rent than an open market review in a rising market. However, this is not always the case.

Turnover rent review: Here the review is based on the Tenant’s turnover. This type of arrangement is commonly found in the retail and catering sector.

Stepped rent increases: This is an alternative method, under which fixed increases at particular dates are agreed at the outset and are documented in the Lease.

“Upwards Only” open market reviews and “Collars and Caps”:

An “upwards only” review fixes the rent payable at the review date as the minimum rent which is payable following the review. This can mean that, in a falling rental market, a Tenant can end up paying above the market rent.

In an “upwards and downwards” review, the rent can go up or down following the review. These reviews are less

common, even when market conditions are poor for Landlords. A review clause of this type could significantly affect the value and marketability of the Landlord’s asset and, as a result, the availability of financing.

Collars and caps: Rent review clauses sometimes include a ‘collar’ and/or a ‘cap’.

In this context:
• a ‘Collar’ is the minimum rental increase that the parties agree will be payable following the review, and
• a ‘Cap’ is the maximum rental increase that the parties agree will be payable following the review.

In this type of review, the open market rental value is calculated first (in accordance with the rent review clause). That rental value is then subject to the applicable “Cap” and/or “Collar”.

So, if the passing rent is £20,000 per year, the open market rent value is calculated as £30,000 per year, and the “cap” is £25,000 per year, then the new rent payable from the review date will be £25,000 per year.

A “Cap” can be agreed with or without a “Collar” and vice versa. A Collar or Cap can be a specified sum, or it can be calculated by reference to a formula. It may be beneficial to include worked examples.

Whether a Collar and/or a Cap is appropriate in a particular transaction is sector and market dependent and will depend on the relative bargaining strength of the parties.

A typical upwards only market rent review clause is likely to contain :
• a definition of ‘open market rent’
• the mechanism to initiate and agree the rent review
• the mechanism to refer the review to third party determination if the parties can’t agree the reviewed rent
• an operational clause stating that, following the rent review date, the new rent will be the higher of the rent reserved immediately before the relevant review date, disregarding any rent suspension then in operation, and the ‘open market rent’ as at the relevant review date .

Rent review : Considerations at “Heads of Terms” stage:

“Heads of Terms” (i.e. a brief outline of the principal terms of the Lease) often do not contain much detail other than the frequency and type of review (e.g. open market or index linked).

Including the frequency and type of review in Heads of Terms is a mandatory requirement for members of the Royal Institution of Chartered Surveyors (RICS) under the Lease Code 2020. The parties may also want to specify the hypothetical Lease term (see below) and the treatment of any break options on rent review so that these matters are dealt with “up front”,  as they too can have a significant effect on valuation.

The parties also need to be aware of transaction-specific matters in the Heads of Terms, as they may highlight the need for specific adjustments to rent review clauses, including for example in connection with assumptions and disregards.

In each case the parties should agree how the relevant item should be treated. Relevant transaction-specific matters may include, but are not limited to:

• the Landlord is building or refurbishing the premises: here the parties may agree that, at rent review, the property will be assumed to be in the (usually anticipated finished) state and condition set out in an agreed specification to be attached to the Lease.
• the Tenant is to carry out works or incur expenditure other than a typical fit out; here the parties should consider who is paying for these works and whether the works should be disregarded on review.
• the Lease may contain potentially onerous provisions such as a ‘keep open’ obligation (where the Tenant is obliged to continue to trade from the property, even if it would mean doing so at a trading loss) or ‘offer back’ clauses (where the Tenant agrees to offer a right of first refusal to the Landlord if the Tenant wishes to assign or underlet).
• the Tenant is offered a personal concession either in the Lease or in a side letter (e.g. the ability to pay rent monthly, rather than quarterly).
• the Parties have agreed a minimum (and/or maximum) floor area by reference to which to calculate the rent (e.g. in circumstances in which the Landlord is constructing premises under an Agreement for Lease).

There is no single answer to the question of how something of this nature should be treated. It will depend on the premises and the terms agreed. The rent review provisions should be a fair reflection of the terms agreed by the parties.

The Tenant will not want to pay twice for anything (e.g. both through obligations in the Lease and through an increased rent). This usually means that:

• if a Tenant pays for improvements to the property, it would not expect to have to pay an increased rent arising from the increased rental value attributable to those improvements
• if a Tenant accepts onerous Lease provisions, the hypothetical Lease used to calculate the rent payable on review should also reflect the same onerous provisions, so that the Tenant is not paying for a hypothetical degree of flexibility that it does not in practice actually have.

The parties should always remember that Solicitors are not valuers. A rent review surveyor should be asked to appraise any provisions which are unusual, or which (for example) require the parties need to make significant choices (such as the length of the hypothetical term or the date of a hypothetical break option).

Avoiding “Headline Rent” reviews : Rent-free periods for fitting out only:

In a falling market, Landlords may offer Tenants ancillary financial inducements to take a Lease in order to maintain the level of rent stated on the face of the Lease.

That higher level of rent, which the Tenant is (only) willing to pay after taking account of the inducement, is a known as a ‘Headline Rent’.

Landlords will often prefer a “Headline Rent” to appear on the face of the Lease because it protects the value of their investment and prevents the creation of unhelpful (to the Landlord) comparable rents.

So, for example, a Landlord may prefer a rent of £30,000 per year for the first five years of the term with a concession to the Tenant of a year-long rent-free period at the start of the term, rather than a rent of £24,000 per year payable throughout those five years, with no rent-free period.

The Lease Code 2020 specifies that Headline Rent review clauses should not be used unless that has been expressly agreed by the parties, typically where the use of them is agreed in return for a financial inducement.

A Headline Rent review clause will direct the valuer to disregard rent-free or reduced rent periods that may be offered in the market at the rent review date.

This is usually achieved by including an assumption that the Tenant has already received the benefit of any rent-free or reduced rent period negotiated in the market, or by directing that the open market rent at review will be the rent payable after the expiry of any such rent-free or reduced rent period.

A typical Headline Rent clause may provide for the open market rent to be that payable after the end of a rent free or reduced rent period of such length as would be negotiated in the open market between a willing Landlord and a willing Tenant.

A well-advised Tenant may not accept this, because it may deprive the Tenant of the benefit of any rent-free period or financial inducement that would be available to it in the assumed open market on the rent review date.

However, if the Tenant has received the benefit of a rent-free period solely for the purposes of fitting out on the grant of a Lease, it is generally accepted that they should not also have the benefit of a further rent-free period solely for fitting out on the review date (given that no further fit out will actually be taking place).

So, an acceptable compromise may be for the Lease wording to provide for the open market rent to be that payable after the end of a rent free or reduced rent period (if any) of such a length as would be negotiated in the open market, between the willing landlord and the willing tenant, at the review date, in respect only of fitting out works which would be carried out by a willing Tenant.

Triggering rent reviews:

The parties should be free to agree the reviewed rent at any time, and both parties should be able to refer the review to an independent third party for determination if they are unable to agree the rent.

Leases will often provide that a third party referral can happen if the parties have not agreed the rent by a specified time (e.g. three months) before the relevant review date. Tenants should ordinarily resist any provision which prevents the Tenant from implementing a review after a specified date.

Tenants should also resist provisions which allow the Landlord to serve a ‘deeming’ notice. In this type of provision, the Landlord may serve a notice specifying the new increased rent and, if the Tenant fails to respond within the specified time limit, it is deemed to have agreed that rent.

Part 3 of the Lease Code 2020 states that Leases should allow either party to start the rent review process, and should not impose time limits intended to prevent a review or to set a new rent through inaction by either party.

Defining the review dates:

It is preferable to state the rent review dates in the Lease as specific dates, rather than (for example) anniversaries of other dates, which can cause uncertainty.

The parties should also remember that, if there has been a material delay between the Heads of Terms stage and completion, the review dates that were originally agreed may no longer be appropriate.

Open market rent definition:

An open market rent review clause typically includes a definition of ‘open market rent’, which in turn comprises:

• a description of the terms of a hypothetical Lease
• a list of assumptions to be made, and
• a list of matters to be disregarded.

“Best rent”: Some definitions of ‘open market rent’ refer to the ‘best’ rent that is achievable. Although the ‘best’ rent may be the same as an open market rent, ‘best’ rent allows a valuer to take account of “special” bids (i.e. the often higher rent that a “special party” —such as an adjoining Tenant —may be willing to pay).

In addition, given that most valuers will say that the rent for a property falls within a range of values (and so will typically opt for a rent in the middle of that range), the ‘best’ rent would be the rent at the top of that range.

A requirement for the hypothetical Lease to be at the ‘best’ rent’ is therefore Landlord friendly.

“Fair” or “Reasonable” rent: These terms are usually avoided by Landlords as they require a subjective test of what would be fair or reasonable for the Tenant to pay. That may not necessarily be the open market rent.

The “Hypothetical Lease”:

A hypothetical Lease of the property, taken as being granted on the relevant rent review date, is the basis of most open market rent reviews. The parties should aim to define the hypothetical Lease so that it resembles the actual letting as far as possible.

It is “standard” practice to provide that the hypothetical Lease is to be granted with vacant possession, without payment of a fine or premium, and by a willing Landlord to a willing Tenant.

In addition, it is not unusual for Tenants to accept an assumption that they have had the benefit of a rent-free period or similar inducement for the purposes of fitting-out only (given that no further fit out will actually be taking place). However, Tenants should ordinarily ensure that any other rent-free period then common in the rental market is taken into account in the valuation to avoid a ‘Headline Rent’.

Unless there are specific assumptions and disregards which clearly show otherwise, the parties will be taken as having intended the hypothetical Lease to be a letting on the same terms (except for the amount of rent, but ordinarily including the same provisions for it’s review) as those subsisting between the parties in the actual Lease.

The parties should carefully consider the proposed terms of the hypothetical Lease and take advice from a rent review surveyor where there are unusual Lease terms, or terms that are particularly affected by market conditions, such as the length of the term of the hypothetical Lease, or the inclusion of a Tenant only break option.

Length of Hypothetical Lease term: The parties should seek advice from their surveyors on the length of term to be valued because the effect on the rental value will vary depending on the nature of the property and the prevailing market conditions.

For example, a Tenant might be prepared to pay more for a shorter term where flexibility is important to its business. However, this may not be the case if the Tenant has incurred significant fit-out costs and would need a longer term to justify and recover the costs incurred.

Tenants should ordinarily resist any attempts by Landlords to “hedge their bets” by reserving the ability to choose between valuing whichever length of term (e.g. the residue of the contractual term, or a defined term of years) produces a higher rent.

If it is proposed that the Hypothetical Lease term should be equal to the residue of the contractual term as at the relevant rent review date, both parties should take advice from their surveyors on the potential implications.

So, for example, and with a contractual term of 20 years, at year five the parties will be valuing a 15-year term, and at year 15 a five-year term. The difference may well be significant.

The rental value of a Hypothetical Lease with a longer term will also be affected if that Hypothetical Lease includes a Tenant break option, because it provides greater flexibility for the Tenant.

Treatment of break options in the hypothetical term:

If a Lease includes a break option, the parties should agree the appropriate treatment of that break right in the Hypothetical Lease.

A Tenant’s break option without strict pre-conditions (for example full compliance with covenants and provision of vacant possession) will potentially increase the rent payable because it allows the Tenant greater flexibility.

If the Lease includes a Tenant’s break option, Landlords will often require the Hypothetical Lease to include a Tenant’s break option on the same terms.

Conversely, a Landlord’s break option could reduce the rent payable. Tenants should therefore make sure that rent is assessed at the rent review by including a Landlord’s break option on the same terms in the Hypothetical Lease.

As a rent review clause will normally specify that the Hypothetical Lease is on the same terms as the actual Lease, then (unless the rent review provisions specifically provide otherwise) it is likely that any break options will be imported into the hypothetical Lease.

However, if the hypothetical Lease is silent in relation to any break option, then the definition of the break date in the actual Lease (i.e. whether it is a fixed date or drafted as an anniversary of the date on which the term starts) will affect the treatment of the break right in the hypothetical Lease. A fixed break date in the actual Lease that is before the start of the term of the hypothetical Lease will not be incorporated into the hypothetical Lease unless there is express provision to that effect.

Where a break option is to be expressly incorporated into the hypothetical Lease, the wording required to define the break date in the hypothetical Lease will be dictated by how the break date is defined in the actual Lease.

For example, if the actual Lease specifies particular dates, and those dates represent the fifth and tenth anniversaries of the start of the term of the actual Lease, then those dates may have passed by the relevant review date (and so will be disregarded) or may fall at a different point in the hypothetical Lease term. They may therefore have unintended consequences for valuation.

Instead, the review provisions might provide that the hypothetical Lease is:  ‘otherwise on the same terms as this Lease…but the Break Date is the fifth and tenth anniversary of the term commencement date of the [relevant] Review Date’.

Tenants should resist any drafting which seeks to manipulate the break date to increase the rent.

For example, consider a Lease with a 17-year actual term, five yearly rent reviews, a break option at year 12, and the hypothetical term is agreed to be ten years. If in this case the actual break date is incorporated into the hypothetical Lease, the result is:

• first rent review (year five of the actual Lease term)—there is a break option in the hypothetical Lease at year seven of the hypothetical ten year term
• second rent review (year ten of the actual Lease term)—there is a break option in the hypothetical Lease at year two of the hypothetical ten year term
• third rent review (year fifteen of the actual Lease term )—there is no break option in the hypothetical Lease.

This might be what the parties intend, but it should be checked, and advice from rent review surveyors taken on the effect on rent of each break date.

Treatment of onerous lease terms

If the parties have agreed anything unusually restrictive, burdensome or personal in the Lease, they should always check how those provisions will be dealt with on rent review.

As a general point, if a Tenant has been obliged to agree an onerous obligation or restriction in the actual Lease (for example a restrictive user clause, which may not only restrict the Tenant’s use, but also restrict the Tenant’s ability to underlet and/or assign the Lease), the Tenant should resist any attempt by the Landlord to disregard it on rent review. Otherwise, the Tenant has an onerous obligation that is not taken into account at rent review and, therefore, no reduction in the rent to reflect it.

What is “onerous” will depend on the market at the time.

Treatment of side letters and ancillary documents

If the parties have used a side letter to document an arrangement (perhaps a personal concession such as the ability to pay rent monthly, or the relaxation of an alienation covenant), they need to think about whether that arrangement should be valued on review. If so, clear wording should be added because the side letter will not necessarily be regarded as part of the ‘Lease’.

If there is a separate document (for example a car parking Licence) relating to the Tenant’s occupation, the Landlord may want the review provisions to reflect the benefit of this to the Tenant (and especially so if the right to park is a necessity). From a Tenant’s perspective, if the Licence to park is a personal right only for the benefit of the named Tenant, and can be withdrawn by the Landlord, the Tenant may well argue that it should not be valued.

Tenants should also consider whether there is anything “special” about the circumstances of their occupation : for example they may occupy an adjoining unit under a separate Lease. If the Tenant needs to use the adjoining unit to enjoy its own premises (perhaps the toilets are in the adjoining unit), the Landlord may look to include an assumption that the hypothetical Tenant has the right to use the toilets within the adjoining unit. This might seem fair (to the Landlord)  but a Tenant should argue that it is paying rent for the adjoining unit and so the Landlord should not benefit (in effect twice) from this.

If a Tenant has negotiated an essential right (such as a right to park) from someone other than the Landlord, the Landlord should not be permitted to value that right: the Tenant has procured it independently and should not the pay a higher rent as a result. The basic premise remains that the Tenant should not have to pay for something twice.

Assumptions:

Rent Review provisions will typically include assumptions:

A. Vacant possession; This is a “standard” assumption in an upwards only rent review clause. It means that the following factors will not affect the market rent on rent review:

• the Tenant’s occupation of the premises
• any underleases in place at the rent review date
• any lawful or unlawful occupation of the premises by any other third party

The aim is to reflect the position at the time of the grant of the original Lease.

B. If the premises have been damaged or destroyed, they have been reinstated.

The hypothetical Lease rent is valued as at the relevant rent review date. On that date, the premises (or other land over which the Lease grants rights to the Tenant) may have been damaged or destroyed by an insured risk, or an uninsured risk. Rent review clauses usually assume that, if there is any such damage, it has been reinstated.

Tenants will ordinarily be able to agree to this because the Lease should contain suitable rent suspension provisions and/or provisions for termination in these circumstances.

Any increased rent should therefore only be payable as and when the Tenant can occupy and use the premises, or when it has a right to terminate the Lease. The Landlord should not be penalised by a reduced rent attributable to damage which is reinstated before the next rent review date.

C. Compliance with Lease covenants.

Tenants will usually argue that there should be no assumption that the Landlord has complied with the Landlord’s obligations if, in fact, the Landlord has failed to comply with them because, otherwise, the Landlord would benefit from it’s own breach.

However, the Landlord may argue that:

• it is open to the Tenant to take action against the Landlord for it’s breach, and
• it is not appropriate for the Tenant to seek a discount on rent review for the next (say) five years for a breach which could be remedied within, say, one month

A potential compromise may be that the assumption does not apply if the Landlord is in material, or persistent breach, or if the Landlord fails to remedy the breach after receiving notice to do so from the Tenant.

D. Rent free periods and ‘fitting out’.

Landlords generally want to ensure that, on review, no reduction is made to the rental value to reflect any inducement, rent-free period or rent concession normally granted to an incoming Tenant for it’s fitting-out works. This is because, in reality, the Tenant has already received this benefit on the grant of the Lease.

Frequently, this is dealt with by an assumption that the Tenant has had the benefit of any inducement, rent-free period or rent concession normally granted to an incoming Tenant for it’s fitting-out works.

Alternatively, the parties may try to address this point by including an assumption that the premises have been fitted out. However, an assumption that the premises are fitted out should address all the issues that it raises, including:

• whether the property is fitted out for the actual or hypothetical Tenant
• what the fit out comprises, and
• who has paid for the fit out.

Tenants should make sure that they are not paying an increased rent as a result of an assumed fit out that has not been carried out, or that the Tenant has paid for.

In addition, the parties should consider the interaction with any other assumption relating to the Tenant’s fit out or improvement works. An assumption that the premises are ‘fit for immediate occupation and use’ will not direct the valuer to assume that the premises are fitted out.

Disregards:

Here, the key principles are that:

• the Landlord should not benefit from an increased rent if the increase is due to the efforts of the Tenant, and
• equally, if the Landlord benefits from strict provisions within the Lease (such as a restrictive user clause), those provisions should not be disregarded on review.

Rent Review provisions will typically include disregards about:

A.Occupation

Although a rent review clause will typically require the valuer to assume that the Lease is granted with vacant possession, any previous occupation of the premises by the Tenant (or any other occupier) may influence value and should ordinarily be disregarded.

If a Tenant occupies an adjoining unit as well as the premises, the Tenant should seek a disregard of the occupation of the adjoining premises, to avoid any argument that the Tenant would pay more than the open market rent to secure the premises.

B.Goodwill

By the time the rent review date occurs under the Lease, the Tenant (or its predecessor) will have been operating its business from the premises for a period and may have built up goodwill in connection with the premises. That goodwill is due to the efforts of the Tenant. The Landlord should not then benefit from any resulting increase in rental value.

Tenants should therefore ensure that the rent review clause expressly disregards any goodwill that has accrued due to:

• the Tenant’s business
• the business of the Tenant’s predecessor(s) in title, or
• the business of any other lawful occupier (including any undertenant)

C.Improvements

In broad terms, an improvement is something which goes beyond repair and improves the premises.

If the rent review provision is silent in connection with improvements, they will be taken into account at rent review, irrespective of who carried them out and who paid for them.

This default position may be unfair to the Tenant.

The parties should expressly agree the position in relation to:

• improvements carried out at the Tenant’s cost : if the Tenant has carried out an improvement at its own cost and the improvement increases the value of the premises then it is not fair for the Tenant to pay an increased rent because it would be paying for the improvement twice (first for the cost of the works and secondly through the increased rent). The Tenant should ensure that the improvement is disregarded.
• improvements carried out before the start of the term : it is common for Tenants to carry out works prior to the start of the term. If the Tenant pays for those works, the disregarded improvements should not be limited to those carried out during the term.
• improvements carried out under a previous Lease : on a Lease renewal, the Tenant should ensure that any works carried out at its cost during the previous Lease term (or prior to the grant of the previous lease) are expressly disregarded
• improvements carried out by third parties : the disregarded works should not be limited to those carried out by the Tenant  – the Tenant might engage others to do works. Works carried out by undertenants and predecessors in title should also be caught by the disregard. One approach is to disregard improvements carried out ‘other than at the cost of the Landlord’.
• improvements that the Tenant is under an obligation to the Landlord to do : Leases often include obligations for the Tenant to carry out works. Those works may or may not be at the cost of the Landlord. If the Tenant covenants with the Landlord to do works at the Tenant’s own cost, this obligation should be reflected into the overall structure of the transaction.  For example, the Tenant may be entitled to a rent-free period, or a reduced initial rent, to offset the cost of the works. Ordinarily, the Tenant should not benefit from works that it is obliged to do as part of the wider transaction. The parties may agree that these works should be excluded from the general disregard of improvements carried out by the Tenant. However, common exceptions are works that the Tenant is required to do to comply with statutory obligations/requirements (see below)
• improvements required by statute : Leases ordinarily include a covenant by the Tenant to comply with statutory and other “official” requirements and obligations. The Tenant will therefore be under an obligation to the Landlord to carry out improvements and other works to comply with statute.

Rent review provisions ordinarily provide for improvements that the Tenant is under an obligation to the Landlord to carry out to be taken into account on rent review, and therefore “rentalised”.

Unlike contractual obligations to carry out specific works, an obligation to carry out works to comply with statute may include unanticipated works requiring capital expenditure by the Tenant, and/or which result from a change in law, e.g. the introduction of the requirement to make ‘reasonable adjustments’ under the Equality Act 2010.

Particularly in a shorter term lease, the parties may agree that this capital risk should be allocated to the Landlord, or shared between the parties.

The parties should in any event expressly agree how statutory improvements carried out by the Tenant will be treated on rent review.

A Landlord may object to a disregard of improvements required by statute, because disregarding them means that the assumed premises would not comply with statute and therefore would generate a lower rent. The Tenant’s argument is that the lower rent is appropriate as it has had to incur an unexpected capital cost. The fair rental value of the premises should therefore be the rent that a Tenant would be willing to pay for premises where it is obliged to carry out the works necessary to make the premises comply with statute. Ultimately, the final position on this point is a commercial negotiation between the parties.

• improvements requiring Landlord’s consent : the review provision may state that only those works for which the Landlord’s consent has been obtained will be disregarded.

This is a useful point for Landlords to make if a Tenant has carried out alterations without consent (and an incentive for Tenants to ensure that they obtain and document consent for alterations where necessary).

The Tenant may want the wording to confirm that the works will still be disregarded, notwithstanding the lack of consent, if the Landlord has withheld consent unreasonably.

Disregards:

Here, the key principles are that:

• the Landlord should not benefit from an increased rent if the increase is due to the efforts of the Tenant, and
• equally, if the Landlord benefits from strict provisions within the Lease (such as a restrictive user clause), those provisions should not be disregarded on review.

Rent Review provisions will typically include disregards about:

A.Occupation

Although a rent review clause will typically require the valuer to assume that the Lease is granted with vacant possession, any previous occupation of the premises by the Tenant (or any other occupier) may influence value and should ordinarily be disregarded.

If a Tenant occupies an adjoining unit as well as the premises, the Tenant should seek a disregard of the occupation of the adjoining premises, to avoid any argument that the Tenant would pay more than the open market rent to secure the premises.

B.Goodwill

By the time the rent review date occurs under the Lease, the Tenant (or its predecessor) will have been operating its business from the premises for a period and may have built up goodwill in connection with the premises. That goodwill is due to the efforts of the Tenant. The Landlord should not then benefit from any resulting increase in rental value.

Tenants should therefore ensure that the rent review clause expressly disregards any goodwill that has accrued due to:

• the Tenant’s business
• the business of the Tenant’s predecessor(s) in title, or
• the business of any other lawful occupier (including any undertenant)

C.Improvements

In broad terms, an improvement is something which goes beyond repair and improves the premises.

If the rent review provision is silent in connection with improvements, they will be taken into account at rent review, irrespective of who carried them out and who paid for them.

This default position may be unfair to the Tenant.

The parties should expressly agree the position in relation to:

• improvements carried out at the Tenant’s cost : if the Tenant has carried out an improvement at its own cost and the improvement increases the value of the premises then it is not fair for the Tenant to pay an increased rent because it would be paying for the improvement twice (first for the cost of the works and secondly through the increased rent). The Tenant should ensure that the improvement is disregarded.
• improvements carried out before the start of the term : it is common for Tenants to carry out works prior to the start of the term. If the Tenant pays for those works, the disregarded improvements should not be limited to those carried out during the term.
• improvements carried out under a previous Lease : on a Lease renewal, the Tenant should ensure that any works carried out at its cost during the previous Lease term (or prior to the grant of the previous lease) are expressly disregarded
• improvements carried out by third parties : the disregarded works should not be limited to those carried out by the Tenant  – the Tenant might engage others to do works. Works carried out by undertenants and predecessors in title should also be caught by the disregard. One approach is to disregard improvements carried out ‘other than at the cost of the Landlord’.
• improvements that the Tenant is under an obligation to the Landlord to do : Leases often include obligations for the Tenant to carry out works. Those works may or may not be at the cost of the Landlord. If the Tenant covenants with the Landlord to do works at the Tenant’s own cost, this obligation should be reflected into the overall structure of the transaction.  For example, the Tenant may be entitled to a rent-free period, or a reduced initial rent, to offset the cost of the works. Ordinarily, the Tenant should not benefit from works that it is obliged to do as part of the wider transaction. The parties may agree that these works should be excluded from the general disregard of improvements carried out by the Tenant. However, common exceptions are works that the Tenant is required to do to comply with statutory obligations/requirements (see below)
• improvements required by statute : Leases ordinarily include a covenant by the Tenant to comply with statutory and other “official” requirements and obligations. The Tenant will therefore be under an obligation to the Landlord to carry out improvements and other works to comply with statute.

Rent review provisions ordinarily provide for improvements that the Tenant is under an obligation to the Landlord to carry out to be taken into account on rent review, and therefore “rentalised”.

Unlike contractual obligations to carry out specific works, an obligation to carry out works to comply with statute may include unanticipated works requiring capital expenditure by the Tenant, and/or which result from a change in law, e.g. the introduction of the requirement to make ‘reasonable adjustments’ under the Equality Act 2010.

Particularly in a shorter term lease, the parties may agree that this capital risk should be allocated to the Landlord, or shared between the parties.

The parties should in any event expressly agree how statutory improvements carried out by the Tenant will be treated on rent review.

A Landlord may object to a disregard of improvements required by statute, because disregarding them means that the assumed premises would not comply with statute and therefore would generate a lower rent. The Tenant’s argument is that the lower rent is appropriate as it has had to incur an unexpected capital cost. The fair rental value of the premises should therefore be the rent that a Tenant would be willing to pay for premises where it is obliged to carry out the works necessary to make the premises comply with statute. Ultimately, the final position on this point is a commercial negotiation between the parties.

• improvements requiring Landlord’s consent : the review provision may state that only those works for which the Landlord’s consent has been obtained will be disregarded.

This is a useful point for Landlords to make if a Tenant has carried out alterations without consent (and an incentive for Tenants to ensure that they obtain and document consent for alterations where necessary).

The Tenant may want the wording to confirm that the works will still be disregarded, notwithstanding the lack of consent, if the Landlord has withheld consent unreasonably.

Third party determination—expert or arbitrator?

Landlords may try to retain the ability to choose whether the third party determining the new rent will act as an arbitrator or expert. The Tenant should ask it’s surveyor to give an opinion on which option is better.

In very short terms:

• experts tend to be cheaper and quicker; their decisions cannot be appealed against, but they can be sued in negligence.
• arbitrators have wide statutory powers. The parties may prefer an arbitrator if the premises are unusual in nature, or of high value, or where the rent review process is a particularly complex one.

Rent review memorandum.

The Lease should provide for both parties to sign and exchange (typically at their own cost) a rent review memorandum, recording the rent agreed at any rent review, so there is clear evidence of the agreement reached, even if no increase is agreed.

Payment of backdated rent and interest

Rent Review provisions typically confirm that:

• pending agreement or determination of the new rent, the “old” rent will continue to be payable at the existing rate
• once the new rent is agreed or determined, the Tenant must pay the shortfall (if any) between the new and old rent with effect from the rent review date
• any interest on the shortfall will be payable at a base lending rate (and not – from the Tenant’s perspective – at any higher/penal rate) and be calculated from the date on which each payment of rent was due (e.g. the relevant quarter day after the review date) rather than being calculated on the assumption that the whole amount is due from the review date itself.

Is time of the essence?

Rent Review provisions will ordinarily confirm that time is not of the essence in connection with reviews (including so that there is less chance of “missing” a review). However, this can be rebutted if:

• there is an express statement that time is of the essence
• the wording used confirms that time limits are, including in conjunction with surrounding circumstances (for example where the rent review is linked to a break option), strict.

(This article is not intended to be comprehensive or to provide specific legal advice. It should not be relied upon in the absence of specific advice given in relation to particular circumstances.)

For further information, please contact: Natalie Linehan, Andrew Williamson or David Thorp