This set of notes covers all of the outcomes for workshop 9 of the Advanced Real Estate module. It also includes case names that can be used and applied in certain exam scenarios- helping to boost your grade!
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Drafting and negotiating commercial leases: rent review
Outcomes:
1. Explain the respective views of the landlord and the tenant on rent review provisions in a
commercial lease.
2. Negotiate the rent review provisions of a typical lease, acting either for the landlord or tenant.
3. Advise on the compliance of the rent review provisions in a lease with the recommendations
contained in the RICS Professional Statement and Code of Practice for Leasing Business
Premises in England and Wales
Types of rent review clauses:
Fixed increase the rent will increase to a fixed amount at the review date, therefore they set a
specific increase every few years, but this is rarely used as it places faith in the
fixed increases being reflective of the current market and it may not be realistic and
not beneficial for either the tenant if they are paying more than they should or the
landlord is receiving less than they could.
This is simple and certain but not often used because of the unpredictability of the
future.
Index-linked clause This clause will increase or decrease the rent in line with an index reflecting
changes in the value of money, the usual index that is favoured is the Retail Prices
Index, this is used as a domestic measure of inflation in the UK and therefore, rent
can change in line with the rate of inflation.
This does not really track the property market specifically and thus can still be
discrepancy between the reviewed rent and the market rent.
Turnover rent reflective of the turnover of the tenant’s business of profits from sub-letting and
therefore, can only be considered by the landlord where turnover is generated at the
rented premises.
This would be inappropriate for an office but may be suited to a retail outlet. This is
usually calculated by the tenant paying a base rent that will usually be a percentage
of the open market rent, plus the top-up rent that is based on a percentage of the
turnover, which is usually between 7-15% of the turnover
Advantage of the turnover rent is that both the landlord and tenant have an interest
in the success of the tenant’s business, as the profitability will be reflected in the
rent review. However, the downside of this mechanism is that if the business that
operates in the premises fails to thrive, the landlord will struggle to obtain a healthy
top up in rent and therefore, before using this method, it would be wise for the
landlord to make a commercial analysis of the operation of the prospective tenant,
with an observation to the character of the business, how long it has been operating
and whether it would be successful operating from that premises.
Open market rent review : most used in practice
OMR review requires the rent to be reviewed in line with the current property
market (different from index linked clauses as the index reflects the increase in
inflation, this follows the value of the property market and conditions).the most
common way to incorporate this is that every rent review date, the parties will seek
to agree upon a figure that equates to what is the current OMR for a letting of the
tenant’s premises.
Thus, calculating how much a tenant would be paying in rent, if they were renting
under the current market conditions and therefore, this could be either
advantageous or disadvantageous depending on the property market conditions.
, Two types of OMR review:
The upwards only rent review
The upwards/downwards rent review
Upwards only OMR review
Upwards only: the rent will be the higher of the two, either the current rent, or the
OMR, therefore, the rent will never decrease, it will either increase or remain static.
This method protects against the vagaries in the property market and therefore will
always be beneficial for a landlord. However, this is less beneficial for a tenant as
they will always be expected to be paying a rent that may increase, or if remains
stagnant, that would be because the property market has not improves and
therefore the tenant would be paying less in the open market.
2020 RICS Code
Para 4: rent review- doesn’t advise against upwards rent reviews but does
suggest that it should be set out in the heads of terms so the tenant is
informed at can take independent advice
4.1 The initial rent, the frequency of payment and whether the landlord
intends to charge VAT on the rent should all be clearly stated, together with
details of any rent-free period or other incentive. The initial rent may be a
fixed sum or expressed as a certain sum per square foot or square metre,
in which case the method of measurement should be stated.
4.2 Where the landlord proposes that rent is to be subject to review, the
tenant should be notified of the proposed frequency and the method or
formula of review at the outset in order to obtain early professional advice
as to the implications.
4.3 Rent review clauses should be clearly expressed. Definitions of market
rent should not result in a ‘headline rent’ unless that has been expressly
agreed by the parties, such as where that is agreed in return for a financial
inducement. Provisions for indexed rent reviews should not contain obscure
formulae designed to produce a greater increase than is proportionate to
the increase in the index over the appropriate period or outside any agreed
caps or collars.
4.4 Leases should allow either party to start the rent review process and
should not impose time limits intended to prevent a review or set a new rent
through inaction by either party.
Upwards/ Downwards rent o The revised annual rent will be reflective of the OMR as determined
review in accordance with the lease and will reflect any increases or
decreases in rental levels that have occurred since the start of the
lease or the previous rent review.
o This is beneficial for the tenant as it may benefit from a decreased
rent and therefore will never be paying too much rent in comparison
to competitors as they will not be in an upwards only rent review.
o However, the main disadvantage for the landlord is that it may
experience dramatic falls in rental levels and thus is a risk to the
landlord’s solvency. Therefore, it is often agreed that the rent will
never fall below a specified figure which is often no less than the
initial rent figures.
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