Rent review clauses are included in leases to allow landlords to periodically review the rent being paid by tenants. These clauses are designed to ensure that the rent being paid is in line with current market rates and to protect the financial interests of the landlord.
Rent review clauses can take different forms, such as linking the rent to the Retail Prices Index (RPI) or the Consumer Prices Index (CPI) or using the concept of a “hypothetical lease” to determine the value of the rent based on assumptions and comparable properties in the area. Rent reviews are usually required to be “upwards-only”, meaning that the rent can only be increased and not decreased. It is important for tenants to carefully review the terms of their leases and be aware of any rent review provisions, as they can have a significant impact on the cost of occupying the leased premises.
The most common method used for rent review is creating a “hypothetical lease”. A hypothetical lease is a fictional lease used to determine the value of the rent being paid under the actual lease. The rent is valued based on assumptions about the terms of the hypothetical lease and by considering rents for comparable properties in the area. These assumptions may include that the parties are willing to enter into a lease for the property, the property is vacant, no premium is payable by either party, the lease has a certain period yet to run, and neither party is in breach of the lease.
However, these assumptions may not always reflect the reality of the situation, and it is important for tenants to be aware of any potential discrepancies. While it is reasonable for a tenant to not be able to rely on their own breach to lower the value of the rent, it is also important to ensure that a landlord cannot ignore their own obligations, such as the obligation to carry out certain repairs. It is generally advisable for tenants to carefully review the terms of their leases and be aware of any rent review provisions, as they can have a significant impact on the cost of occupying the leased premises.
It is also important to consider which of the terms and conditions should be included or excluded in the assumptions. Landlords may try to exclude certain “unfavourable” clauses, such as restrictions on alienation or a break clause in favour of the landlord, from the assumptions of the hypothetical lease. It is generally preferable to reflect reality as much as possible, so tenants should be aware of any potential biases or exclusions in the assumptions and ensure that they are fairly reflected.
On the other hand, certain matters, such as the fact that the tenant is already in occupation and any goodwill that has been generated, should be disregarded. It is also important to ensure that any improvements carried out at the tenant’s expense are not taken into account when determining the rent under a hypothetical lease. Leases will generally only disregard works carried out with the landlord’s consent, so it is important for tenants to obtain the necessary approvals before undertaking costly alterations.
As mentioned above, rent reviews are usually required to be “upwards-only” and in some cases, tenants may seek to cap the amount by which the rent can be increased. Landlords may agree to this but may also require a “collar” to ensure that the rent increases by a minimum amount, such as 1% per year.
There is often an interaction between rent review provisions and subletting in leases. Landlords may include clauses stating that tenants must not sublet their premises at a rent lower than the current passing rent, as this would provide comparable evidence for the rent of the property and could exert downward pressure on future rent reviews under the head lease. However, in a depressed market, such a clause may make it difficult for a tenant to dispose of the property. It is important for tenants to carefully review the terms of their leases and be aware of any provisions related to rent review and subletting, as they can have a significant impact on the ability to dispose of the leased premises.
Please note that this blog is not intended to be legal advice. This material has been prepared for informational purposes only and as general guidance. Is not intended to provide, nor should it be relied on for, legal or tax advice. You should consult your own advisors or seek professional independent advice before engaging in any transaction.
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