PROPERTY JOURNAL

APC: commercial property rent reviews

APC candidates working towards the Landlord and tenant competency will need to be familiar with the essentials when it comes to rent reviews

Author:

Jen Lemen

01 November 2021

APC

Commercial property

Rent reviews are an essential component of the Landlord and tenant competency – but they are often poorly understood by candidates, particularly in more complex cases at Level 3.

The competency concerns the management of the landlord and tenant relationship. It has a broad scope covering all aspects of lease negotiations. Candidates will be expected to understand the issues and how they affect both parties.The three levels are set out in further detail in Figure 1.

Figure 1: Likely knowledge, skills and experience required at each level of the Landlord and tenant competency

Level 1

Level 2

Level 3

Demonstrate knowledge and understanding of the law and practice relating to landlords and tenants. Examples of knowledge at this level are:

• the principles of property law
• the statutory and common-law framework applying to the landlord and tenant relationship
• the content, form and structure of leases
• relevant market conditions and property values.

Apply the principles of the law and practice relating to landlord and tenant. Carry out relevant negotiations to resolve issues affecting owners and occupiers of real estate. Examples of activities and knowledge at this level are:
• reading and interpreting leases
• carrying out market research, collating and analysing comparable evidence
• preparing, serving and responding to legal notices
• entering into negotiations
• instructing legal advisers and seeing matters to conclusion.

Provide evidence of having given reasoned advice, and prepare and present reports on the law and practice relating to landlords and tenants. Apply your knowledge to support relevant dispute resolution procedures. Examples of activities and knowledge at this level are:

• providing appropriate valuation advice

• providing strategic advice on landlord and tenant matters, relating to individual properties or property portfolios
• advising on alternative dispute resolution options in the event that negotiations break down, and taking any necessary action to protect the client's position
• demonstrating involvement with third-party determination and associated submissions
• reaching an agreed solution and reporting recommendations to client
• preparing reports containing recommendations before commencing negotiations.

Figure 1: Likely knowledge, skills and experience required at each level of the Landlord and tenant competency

Level 1

Level 2

Level 3

Demonstrate knowledge and understanding of the law and practice relating to landlords and tenants. Examples of knowledge at this level are:

• the principles of property law
• the statutory and common-law framework applying to the landlord and tenant relationship
• the content, form and structure of leases
• relevant market conditions and property values.

Apply the principles of the law and practice relating to landlord and tenant. Carry out relevant negotiations to resolve issues affecting owners and occupiers of real estate. Examples of activities and knowledge at this level are:
• reading and interpreting leases
• carrying out market research, collating and analysing comparable evidence
• preparing, serving and responding to legal notices
• entering into negotiations
• instructing legal advisers and seeing matters to conclusion.

• providing appropriate valuation advice

Candidates would be well advised to include at least one example of a rent review and one of a lease renewal in each of their Level 2 and 3 competency write-ups. At Level 3, this will include being responsible for a rent review instruction from start to finish.

This article will look at the overall process of dealing with a rent review and the potential pitfalls that candidates may face; however, it will not look in detail at the basis of hypothetical reviews or third-party procedures.

Getting started

Candidates should remember that there is no standard form of rent review or guiding legislation, so each case must be considered on its own facts. Legal advice or help from a more experienced rent review surveyor should be sought if candidates are in doubt.

As always, candidates must check for conflicts of interest and confirm that they are competent to act before accepting a rent review instruction. They should then formalise the instruction in terms of engagement, which need to be signed and returned by their client.

Rent reviews are a key clause found in most commercial leases, with the purpose of reflecting the 'changes in the value of money and real increases in the value of the property during a long term'. Basingstoke and Deane Borough Council v Host Group (1987) 2 EGLR 147 CA confirmed two specific purposes of a rent review clause: to obtain a market rent, and to reflect changes in the value of money and the property.

In the long, 25-year institutional leases that tended to be granted from the 1960s onwards, rents were reviewed typically every five years and always increased the amount; that is, they were upward only. However, given the growing trend for shorter leases since the 2000s, some may have different review provisions – or even none, as for instance in three- or five-year leases.

Rent review clauses

Rent reviews are a common source of conflict between landlords and tenants, given their differing views of where the rent should sit; landlords typically seek a higher rent and tenants the opposite.

While many reviews are agreed by negotiation, a well-drafted rent review clause will provide a third-party dispute resolution mechanism, such as arbitration or expert determination. The latter should not be confused with an expert witness, which is the role that the landlord's or tenant's surveyor will adopt as a third party.

Candidates should be well versed in the different forms of rent review clause they may encounter. These include:

open-market rent or rack rent based on relevant comparables at the review date
index-linked to track inflation; common indices include Retail Price Index and Consumer Prices Index, and calculations should be undertaken at the lease drafting stage to ensure the provisions are reasonable
geared rent, usually based on a percentage of market rent; this basis is typically found in relation to long leases of large buildings or sites, or for subleases
turnover rents, which are becoming more popular for shopping centre retail units in particular; such clauses allow parties to share in both the fortunes and misfortunes of the tenant's profitability, but the calculation basis is often contentious, especially in relation to the way turnover is defined and how figures are reported
fixed increases, set at commencement of the lease.

Rent reviews are not necessarily always upward only, where the reviewed rent can be no lower than the previous passing rent; some rent reviews may allow for either upward or downward revision, a position promoted by the current edition of the Code for Leasing Business Premises RICS professional statement. Candidates may also come across collared and capped rent reviews, limiting the down or upside position – for example, a collar at 1% p.a. and a cap at 2.5% p.a.

As part of their due diligence, candidates need to be able to recognise, and at Level 3 advise on, different types of rent review clause. In a commercial lease, the clause is often found in a schedule towards the end that is referenced in the initial pages.

As well as the lease, candidates should also scrutinise any other legal documents such as rent review memoranda, deeds of variation, agreements for lease, and licences to alter or assign.

Lease features

In an open-market rent review, the lease will set out a hypothetical review basis, including the length of the hypothetical lease. Assumptions and disregards also form part of the hypothetical lease, which means that candidates are not assessing market rent on the actual terms of the lease and the incumbent parties.

Each rent review clause is different because there are no standard clauses. This means that candidates need to analyse the review basis diligently to see how it compares to the market and whether there are any onerous or contentious clauses, such as a headline review clause, i.e., not taking into account any rent free period and thus inflating the market rent, or very limited user clause, i.e., limiting who the hypothetical tenant could be and depressing the level of rent achievable.

If a lease is well drafted, candidates should be able to give a clear summary of the following:

current rent payable, which is typically set out in the definitions at the start of the lease or on the last rent review memorandum
rent review date, which is typically set out in the definitions at the start of the lease
rent review basis
whether time is of the essence, that is whether strict timings are in place that if not followed may forfeit the client's right to review; time is generally not of the essence unless there is emphatic language to this effect or there are contraindications in the rent review or the lease
whether there are trigger notice requirements, whether they are formal or informal, and whether there are any specific requirements
assumptions, such as the subject premises being fit for immediate occupation and use, or that vacant possession is given, that no work has been carried out by the tenant reducing rental value, or that the market rent is payable after the expiry of a rent-free period for fitting out
disregards of the actual tenant's occupation of the premises, goodwill or other factors
hypothetical lease length and the date from which this is calculated, such as lease commencement or the rent review date
penal interest if the rent review is settled after the review date
dispute resolution mechanisms, usually being an arbitrator or expert, along with any requirements as to which party can request the appointment, typically using an RICS DRS 1 form.

The DRS 1 form can be found on the RICS Dispute Resolution Application forms page.

The lease should be read in the context of a physical property inspection, measurement and desktop research, considering for instance the comparable evidence, location and other factors affecting rental value.

'Candidates need to analyse the review basis diligently to see how it compares to the market'

Next steps

After reading the lease, the surveyor should prepare an initial report for the client on the rent review, market rent and negotiating strategy. This will take account of the comparable evidence, market trends, the negotiating power of each party and third-party dispute resolution mechanism.

Depending on whether the candidate is acting for the landlord or tenant, they will then either serve or receive a trigger notice, or simply contact the other side to open negotiations. Whether formal notice is sent or informal contact made, it usually includes a quoting rent, supported by floor areas and comparable evidence.

Agreeing floor areas at the outset can help to reduce the scope of a rent review dispute, as can agreeing the basis of review and any contentious issues. During negotiations, there are a variety of options available to candidates.

Negotiations by email or letter

These should be labelled without prejudice and subject to contract. The former should be used where the surveyor does not want the offer to be cited in subsequent third-party proceedings.
Negotiations by phone, video or in person

Candidates should not forget that verbal communication is more powerful than written forms, allowing rapport to be built and the actual issues at stake to be identified and discussed.
Calderbank offers

Labelled without prejudice save as to costs, a so-called Calderbank offer is a genuine attempt to settle that cannot be disclosed to the third party, other than on the matter of costs. It can also provide protection on costs and is legally binding if accepted, so client approval in writing must always be given before a Calderbank offer is served.
Third-party application using RICS DRS 1 form then third-party proceedings

The cost of third-party proceedings, including the DRS 1 application, should be protected by way of a Calderbank offer.

Following a negotiated settlement or third party proceedings, the final step will be to record the reviewed rent by way of written memorandum. This will be appended to the lease for future reference.

Jen Lemen FRICS is a partner at Property Elite

Contact Jen: Email

Related competencies include: Landlord and tenant