The Covid-19 pandemic has had a significant impact on many businesses. As tenants fall behind on rent payments and landlords are prevented from taking enforcement actions, business tenancies have been under scrutiny for their lack of provisions. We explore, in a series of articles, some of the clauses (and ideas) in commercial leases that will, in the future, attract more attention during the lease negotiation stage. In this second article, we will focus on the rent review clause in a commercial lease.
A rent review clause governs how and when the annual rent will increase during the term of the lease. This clause is essential to the landlord whose objective is to maximise their rental income. Depending on the area and type of property, commercial leases of more than five years typically contain a rent review clause.
The two most common methods of reviewing the rent are:
I.Open-Market Rent review – this is the most common type of rent review used in commercial leases. This method stipulates a list of ‘assumptions and disregards’ to determine the open-market rent payable at the time of the rent review.
II.Index-linked rent review – this uses a price index, such as the Retail Price Index, which measures the inflation and deflation in the prices of goods and services purchased by UK households. This method increases the rent in line with the specified index.
Different rent review methods can result in a different outcome, and which one to use will usually depend on the parties' preference and the type of property. During times of economic growth with high consumer spending, retail spaces will be in high demand, which pushes up the open-market rent for properties in the retail sector. On the other hand, price indexes do not necessarily reflect the economic condition. Therefore, it is possible to have a situation where an index-linked rent review results in a rental increase which would not have been the case if an open-market rent review was used.
So how will the Covid-19 pandemic change the future of rent review clauses? The majority of rent review clauses are on an ‘upward only’ basis. The effect of this clause is that the rent will not reduce despite a downturn in the rental market or negative inflation. A rent review clause that enables the rent to decrease (as well as increase) is rare but is certainly a possibility if the landlord agrees.
Even if an upward/downward rent review cannot be agreed, the rent review clause can be adjusted to balance the position between the landlord and the tenant.
The full scale of the economic damage caused by the pandemic is yet to be realised. However, many businesses will likely scale back their expansion plans or look to downsize their current space. Such activity could impact the property market by forcing landlords to accept more tenant-friendly terms.
If you would like any advice on your existing commercial lease, or on granting or taking a new one, please do not hesitate to contact our Commercial Property team.