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LZ newsletter 006
Rent Review in the Prevailing Climate
Investment is about becoming financially better off. Investing in commercial property can be rewarding provided you know what you’re doing, otherwise risky. Commercial property is a generic term for all types of business premises; offices, factories, warehouses, shops, supermarkets, retail warehouses, factory outlets, trade counters, pubs, restaurants, and leisure. Essentially, a commercial property is a fixed asset whose investment value requires sufficient appreciation to at least counteract depreciation. Successful investment is about judicious choice and timing: what to buy, how much to pay, how to manage, when and how to sell. Generally, assuming the objective is investment, not development, landlords want both capital value and the rent to least keep pace with inflation. Property has a reputation as a long-term hedge against inflation, but not all properties make good investments. Any potential for capital gain and/or rental growth depends on the variables.
The tenant’s objective for the property is a marketing device for the tenant’s business. The tenant does not care about the landlord’s investment. When costs and overheads overshadow the advantages, the tenant moves on. During the tenancy, tenants want to reduce property costs and minimise liabilities but often at the expense of the landlord. To get landlords to be accommodating, tenants use manipulative tactics, such as claiming business is bad, not being able to afford more, and without concessions the tenant would go broke. Some landlords, especially when mortgaged to the hilt or petrified of voids, are so scared they’ll agree to anything. Many unrepresented landlords fall for tenant ploys. It is easy to be influenced by doom and gloom. Of the economy, hardly a day goes by without news of another business collapse or rationalisation, jobs lost. However, the economy rarely has any bearing on individual businesses. The total market for goods and services comprises sectors and segments. Businesses are not all in the same boat. The world does not owe the tenant a living. In my opinion, most problems are self–inflicted, through failure to address operational short-comings.
For landlords whose commercial property is in dire straits, any suggestion of rent review might seem alien. All property belongs to someone. There is nothing new about commercial property ending up in the wrong place: localities, ‘High Streets’, are not sacrosanct, buildings often out-last their useful shelf-life. Tenants go broke by not anticipating change, investors get it wrong by ignoring warning signs.
In stable and thriving areas of the commercial property market, landlords look forward to rent review. Presented with a plea for clemency, any decision whether to implement the review should be made after the rent is agreed or ascertained. To decide against on the basis of a sob–story invites the question ’how do you know it’s not a negotiating ploy? ’ By agreeing no increase without first exploring all the possibilities the landlord risks missing out on rent increase and capital growth. If the landlord could afford to, a lower rent payable could be accepted.
A rent review that’s ‘upward-only’ does not mean the rent necessarily has to go up, simply that after the market rent is agreed or ascertained the rent payable will not be less than the amount payable beforehand (assuming nothing else to the contrary). Since the market rent could be lower than rent payable, there could be repercussions for the investment value if the property were mortgaged. Many landlords commission surveyor reports on the likely rent at review but I consider such reports a waste of money. During negotiations, evidence can emerge that was not known about before, also psychology enters the fray. For example, most tenants are into commercial expediency so, even if there were no evidence, a nominal increase might be offered to avoid the cost of dispute resolution referral.
With commercial property, there is no standard form of lease. Leases are drafted from scratch, to the parties’ requirements, and often using precedents. [The Law Society has devised a short form of lease, but wording can be altered. ] Rent is the product of the terms and conditions of the tenancy upon which the premises are let. Wording should not always be taken literally: there may be overriding legislation, also words and phrases attract connotations; a different interpretation can often result in substantial increases or savings.
When a lease is granted, the terms and conditions are subjective, but the approach at review (assuming market rent, rather than inflation-adjusted, formulaic, or turnover-linked) is objective. Unlike on expiry where, (assuming the tenancy would qualify for renewal rights) rent is based on s. 34–s. 35 Landlord and Tenant Act 1954, a rent review during the term is based on a hypothetical lease, written in the review clause (and any related documents). Open market rent is not what the actual tenant could afford or how much the actual landlord might want, but what rent the premises would fetch if let in the market between a hypothetical willing landlord and hypothetical willing tenant. ’Hypothetical willing’ is defined in business tenancy law. The hypothetical lease may or may not contain the same terms and conditions as the lease so the outcome of the review might not be as envisaged. For example, if when the premises were let the rent reflected a limitation in use of the premises, then an unrestricted use in the hypothetical lease could result in a greater rent at review, all other factors remaining constant. Conversely, an assumed term without a break clause could result in a lower rent.
Where there is no evidence, the answer is to not value back-to-front. Comparable evidence is back-to front: it implies someone else agreed first and for the subject review to follow, pro-rata. Forward-thinking assesses rent by using either one of the other methodologies, or informed opinion. Informed opinion differs from letting agency ‘real-world’ experience because, unlike the actual market where they may be no demand, in the world of the hypothetical anything is possible.
The tenant’s objective for the property is a marketing device for the tenant’s business. The tenant does not care about the landlord’s investment. When costs and overheads overshadow the advantages, the tenant moves on. During the tenancy, tenants want to reduce property costs and minimise liabilities but often at the expense of the landlord. To get landlords to be accommodating, tenants use manipulative tactics, such as claiming business is bad, not being able to afford more, and without concessions the tenant would go broke. Some landlords, especially when mortgaged to the hilt or petrified of voids, are so scared they’ll agree to anything. Many unrepresented landlords fall for tenant ploys. It is easy to be influenced by doom and gloom. Of the economy, hardly a day goes by without news of another business collapse or rationalisation, jobs lost. However, the economy rarely has any bearing on individual businesses. The total market for goods and services comprises sectors and segments. Businesses are not all in the same boat. The world does not owe the tenant a living. In my opinion, most problems are self–inflicted, through failure to address operational short-comings.
For landlords whose commercial property is in dire straits, any suggestion of rent review might seem alien. All property belongs to someone. There is nothing new about commercial property ending up in the wrong place: localities, ‘High Streets’, are not sacrosanct, buildings often out-last their useful shelf-life. Tenants go broke by not anticipating change, investors get it wrong by ignoring warning signs.
In stable and thriving areas of the commercial property market, landlords look forward to rent review. Presented with a plea for clemency, any decision whether to implement the review should be made after the rent is agreed or ascertained. To decide against on the basis of a sob–story invites the question ’how do you know it’s not a negotiating ploy? ’ By agreeing no increase without first exploring all the possibilities the landlord risks missing out on rent increase and capital growth. If the landlord could afford to, a lower rent payable could be accepted.
A rent review that’s ‘upward-only’ does not mean the rent necessarily has to go up, simply that after the market rent is agreed or ascertained the rent payable will not be less than the amount payable beforehand (assuming nothing else to the contrary). Since the market rent could be lower than rent payable, there could be repercussions for the investment value if the property were mortgaged. Many landlords commission surveyor reports on the likely rent at review but I consider such reports a waste of money. During negotiations, evidence can emerge that was not known about before, also psychology enters the fray. For example, most tenants are into commercial expediency so, even if there were no evidence, a nominal increase might be offered to avoid the cost of dispute resolution referral.
With commercial property, there is no standard form of lease. Leases are drafted from scratch, to the parties’ requirements, and often using precedents. [The Law Society has devised a short form of lease, but wording can be altered. ] Rent is the product of the terms and conditions of the tenancy upon which the premises are let. Wording should not always be taken literally: there may be overriding legislation, also words and phrases attract connotations; a different interpretation can often result in substantial increases or savings.
When a lease is granted, the terms and conditions are subjective, but the approach at review (assuming market rent, rather than inflation-adjusted, formulaic, or turnover-linked) is objective. Unlike on expiry where, (assuming the tenancy would qualify for renewal rights) rent is based on s. 34–s. 35 Landlord and Tenant Act 1954, a rent review during the term is based on a hypothetical lease, written in the review clause (and any related documents). Open market rent is not what the actual tenant could afford or how much the actual landlord might want, but what rent the premises would fetch if let in the market between a hypothetical willing landlord and hypothetical willing tenant. ’Hypothetical willing’ is defined in business tenancy law. The hypothetical lease may or may not contain the same terms and conditions as the lease so the outcome of the review might not be as envisaged. For example, if when the premises were let the rent reflected a limitation in use of the premises, then an unrestricted use in the hypothetical lease could result in a greater rent at review, all other factors remaining constant. Conversely, an assumed term without a break clause could result in a lower rent.
Where there is no evidence, the answer is to not value back-to-front. Comparable evidence is back-to front: it implies someone else agreed first and for the subject review to follow, pro-rata. Forward-thinking assesses rent by using either one of the other methodologies, or informed opinion. Informed opinion differs from letting agency ‘real-world’ experience because, unlike the actual market where they may be no demand, in the world of the hypothetical anything is possible.