A different perspective

Amongst my spare-time (if only!) interests is photography. I became  interested in photography as a quick way to write poetry. I wrote reams of poems during my teens, my writing style a combination. For further reading, please visit LandlordZone.

Negotiating Rent Review with your Tenant

It is not compulsory to instruct a surveyor to deal with the rent review and many landlords prefer to have a go at negotiating rent reviews direct with their tenants, particularly local traders and small businesses. For further reading, please visit LandlordZone.

Poso kani - πόσο κάνει - (how much?)

The people running a country are sitting-targets for the sort of people who, themselves not in charge of anything of very much importance, are fond of criticising, that is until… For further reading, please visit LandlordZone.

"Upward only" rent review

Contrary to popular belief, ‘upward-only’ rent review does not mean the rent must increase. For further reading, please visit LandlordZone

Rent Review

The purpose of a rent review (and where the basis is market rent) is to enable the landlord to obtain the market rent for the premises at the review date (or valuation date if different) and for the tenant to ensure it is not paying any more or less.

The open market is made up of different ‘affordabilities’, so, in linking the review to 'open market rent' ("OMR") ‘open’ means everyone and anyone. [In valuation, the word ‘open’ is superfluous. ]

As comparable evidence, a new letting to an inexperienced first-time tenant at a rent that might amaze is as valid as any hard-driven bargain by a company with dozens of branches. So, since rents in the commercial property market are unregulated, any tenant committing to a review to OMR is exposing its business to all manner of risks beyond its control (a situation that can strain compliance with the Turnbull report on internal control and risk management, to safeguard shareholders’ investment and the company’s assets). Similarly, since, in the open market, different landlords are likely to have different investment strategies, risks also apply to the landlord’s investment. Hence, the only way the actual landlord and actual tenant can have any control over the direction of the rental relationship is by recording their requirements in the lease, per the rent review guidelines.

In the market, rent is a product; it does not occur naturally, as in, ‘this is the rent for the premises’. To value rent, all terms and conditions of the tenancy must be known, stated in advance or defined. But, since the rent on a new letting is often agreed before the lease is drafted and/or approved, it is possible for a completed lease to contain terms and conditions that could produce a different rent to what was agreed. The test of efficacy is whether the rent would be identical if there were a rent review on the same date as the term commencement.

A rent review might be thought of greater benefit to landlords but, essentially, benefit is equal. A review ensures the tenant is not subsidised. Of course, tenants do not necessarily see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate.

With the gap widening between those that have what customers want and those that do not, tenants not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. The tenant’s reaction to a proposed increase is likely to be emotional, than dispassionate, but a tenant’s failure to adapt its style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some tenants, but a function of the market, and that includes competition from other businesses, valuation methodology, and tenants straying from review guidelines.

It is pointless for a tenant to agree what it can afford because that could vary over the years: to pay more than necessary when business is booming can mean that rent fixed for the term, regardless. Because terminology is fashionable, guidelines vary from detailed to vague - terms and conditions of a tenancy cannot be changed, except by rectification by the original parties, or mutual agreement - but, whether the intention of the original parties is clear or interpreted, the guidelines are intended to be helpful: to enable the tenant to apply market circumstances at the valuation date to the level of rent.

A rent review is objective: not how much the actual tenant would agree, or the actual landlord would want, but what a hypothetical willing landlord would reasonably expect and a hypothetical willing tenant would pay; such parties may include the actual landlord and actual tenant. So, in addition to procedure for operating the review, time for agreement, method and cost of dispute resolution, and timing of payment and rate of interest on any back rent, the guidelines define the valuation basis for the terms of the tenancy between the hypothetical parties.

There is no such thing as an ‘upward-only rent review’ as such. Upward-only is a cushion for the rent payable and nothing to do with the market rent. So, if the lease contains an “upward-only” review clause, then that does not mean the rent must go up; but that the rent payable after the review cannot be lower than before. Even so, when the landlord expects an increase, that feeling can rub off on the tenant, so the tenant’s first thought is likely to focus on the proposal, rather than how to agree a rent that accords with the guidelines. Landlords can prey on inexperience and unsuspecting - for example, an increase for inflation, or encouraging avoiding the expense of appointing surveyors - so when landlord and tenant communicate directly, it is not unusual for such tenants to settle for a quiet life. But, whereas avoiding confrontation may sometimes be commercially expedient, it makes no sense, at least to me, for a tenant to ignore the guidelines, by thinking that could upset their landlord, when the guidelines are designed to be helpful.

If you are acting for the tenant and do as the tenant asks, but the landlord is unyielding, then for you and/or the tenant to reckon no real likelihood of a surveyor doing any better should, I suggest, be put to the test. It does not follow just because you and your client are not making any progress that a surveyor's experience would also get nowhere. To a landlord (whether represented overtly by a surveyor), a tenant, when negotiating themselves, or through a solicitor or an accountant, is often regarded a ‘soft touch’. Calling a landlord’s bluff - for example, threatening to instruct a surveyor, or referral to ‘arbitration’ - will only work when the landlord is fearful of the prospect. A landlord will wait to see whom the tenant has instructed, before deciding whether to enter into combat.

Although lowest rent is important, it may be all the more where the lease contains a tenant’s option to buy the freehold for the price valuation formula is based on the rent.

In my opinion, things go wrong in the landlord and tenant relationship when negotiations become subjective, and wider consequences for the actual landlord and tenant dominate. It is not simply a clash of personality or viewpoint. Costs can figure largely, the tenant baulks at the expense of referral, angles are not spotted or explored, so a new rent does not reflect the market at the valuation date, but is a product of the past, based almost solely on other rent review and lease renewal agreements. The cumulative effect can take its toll.

To quote from Wallshire Ltd v Aarons [1988] “second best are rent reviews which are negotiated between valuers, because although their aim is to achieve the same end-result of deciding what the market rent is, their decision is not tested by the market; their decision, their agreement, is based on their conclusions about what the market would decide. Negotiated settlements therefore can be unreliable because of the possibility of error piled on error. They need … an occasional window of reality provided by open market decisions. ”

The difficulty for a solicitor, when acting for a tenant, is their advisory role differs from that of a surveyor. Solicitors act only on client instructions, whereas surveyors can act off their own bat. When the tenant tells you the landlord’s proposal is excessive, or such like, and wants to reply with a counter-offer of what he could afford, how the response is received by the landlord is likely to be construed as an outburst, merely letting off steam. While some landlords do overstate, the proposal may in fact be close to market rent. Generally, particularly when substantial increase is proposed, the tenant’s reaction is anticipated. A emotional plea is unlikely to cut any ice. Since a review is a function of tenancy management, the tenant may forget, or not realise, the process is nothing personal.

It is also important to realise the review process is not only about rent, but also whether the review can be implemented and/or the proposal negotiated. Implementation often requires some notice to be given, the notice must be valid, and time-limits adhered to. Similarly, it may be necessary to serve a counter-notice. It is vital to respect the guidelines. Bellinger v South London Stationers Ltd [1979] is an example of what can go wrong: “we would hardly need to add that we do not accept your revised figure” was not considered sufficiently specific to be a counter-notice.

Where many tenants go wrong is not consulting a surveyor. It’s all very well wanting to save on fees by tackling the landlord themselves, or getting their solicitor or accountant to write, but, at rent review, as with anything involving a business tenancy, it’s not simply a matter of the tenant agreeing what it can afford, but what others would agree for the same situation. Anything the tenant agrees by themselves could end up backfiring on them at a later date. Whether through a solicitor or an accountant, a tenant trying to negotiate a rent review without involving a surveyor can leave the tenant with the feeling the cards are stacked in favour of the landlord but, in my experience, how negotiations are handled from the start can make a difference to the outcome.

Negotiation

Contrary to popular belief, there is, assuming the review to market rent, no right or wrong way to negotiate a rent review. The tenant may like to assert that the landlord should produce evidence to justify a proposed increase and if none were forthcoming then the rent should not go up, but that stance has no basis in law. On the contrary, a principle of business tenancy law is that a rent review is for the benefit of both parties, so co-operation is called for.

In United Scientific Holdings v Burnley Borough Council (1978), Lord Salmon said: “To my mind, it is totally unrealistic to regard such clauses (rent review) as conferring a privilege upon the landlord or as imposing a burden upon the tenant. Both the landlord and the tenant recognise the obvious, viz., that such clauses are fair and reasonable for each of them. I do not agree with what has been said in some of the authorities, namely, that a rent revision clause is for the benefit of the landlord alone and not at all for the benefit of the tenant. It is plainly for the benefit of them both. It is for the benefit of the tenant because without such a clause he would never get the long lease which he required; and under modern conditions it would be grossly unfair that he should. It is for the benefit of the landlord because it ensures that for the duration of the lease he will receive a fair rent instead of a rent far below the market value of the property which he demises. ”

A review ensures the tenant is not subsidised. Even so, tenants rarely see it like that; and, for many, the only way the business can remain profitable is when costs are below the going rate. A business plan is rarely straightforward, and with the gap widening between retailers that have what customers want, and those that do not, retailers not on the receiving end of profitable demand are often fighting to preserve an outmoded business model. When the survival of the tenant’s business depends to a large extent upon the landlord not wanting any (hefty) increase, the tenant’s reaction to a proposed increase is much more likely to be emotional, than dispassionate. What might be described as 'woolly-headed liberal thinking' has entered the popular fray but retailing is not an extension of social services. A tenant’s failure to adapt its business style to changing circumstances cannot possibly be something for which the landlord should be expected to share responsibility. It is not a fault of landlords that rents have become uneconomical for some retailers, but a function of the market, which includes competition from other retailers, consumer spending-priorities, rental valuation methodology, and tenants straying from review guidelines.

Negotiation - restoring the balance of power

Notwithstanding Reed Personnel Services plc v American Express Ltd [1996] wherein the court said it is “not good for the tenant to say what is good for the landlord” many tenants are fond of negotiating as if they were the landlord. Although technically cutting no ice, it’s an approach that can succeed when for the landlord to be ‘accommodating’ would be sensible under the circumstances. In this context, accommodating means allowing some slack in compliance with the tenancy. I see no point in incurring time and expense in having a lease and then not sticking to it, but I do realise it is the landlord’s prerogative whether to enforce it to the letter. The landlord and tenant relationship is on-going for the duration of the term and beyond. For routine matters there may be no disagreement, but, otherwise, beyond the law, and valuation, negotiation is about psychology.

Psychology is a science, an academic and applied discipline that involves the scientific study of human or animal mental functions and behaviours. At a down-to-earth level, and in the context of a business tenancy, what psychology does is to interfere with the strictures of the commercial contract by injecting a human element. In 1988, in my booklet, “The Psychology of Rent Review Negotiation” I said the relationship between landlord and tenant should ideally be a partnership, sharing the ups-and-downs together. In practice, the interests of landlord and tenant remain diametrically opposed: the landlord wants more, the tenant wants less. During downturns, the cushioning upward-only review brought about by landlord wanting and the tenant offering to maintain rental income throughout the term does the job intended by both parties. So why should a campaign to abolish upward-only reviews want to alter a mutually accepted perfectly good system? Frankly, I think the answer is self-interest. Instead of rising to the challenge of organic growth - improving upon what exists already in pursuit of excellence - such tenants grow by expansion: they become addicted to momentum and, over-indebted and overstretched, end up disconnected from reality and losing their way. Although in theory expansion makes sense, inorganic growth is never the way to develop a long-term consistently profitable business because too much gets taken for granted. Tenants urging politicians to do something about their business tenancy arrangements when having entered voluntarily into a commercial contract such tenants find that what they signed is not what they had in mind is not the sort of behaviour one would expect of companies surrounded by advisers. Not to be outdone, and despite a muted response from government, many companies and the surveyors that act for them, have got it into their heads that such tenants should be thought of as doing the landlord a favour in wanting to lease the premises.

Asserting the landlord should care whether a tenant can afford the rent is a crafty way for the tenant to get what it wants; it also makes it harder for that particular landlord to enforce the terms and conditions of the tenancy. By removing from business tenancy law and rental valuation the impersonality that is the hallmark of the market, rent review and tenancy expiry/renewal has taken on a new guise. No longer a relatively straightforward application of business tenancy law and rental valuation, now it strongly features subjectivity whereby tenants promote the “wider consequences” for their business in the event that landlord is not accommodating. For example, a recent public display was Thorntons, the chocolatier, telling landlords wanting to increase its rents that Thorntons would close the shops and trade on the Internet instead. I think it fascinating a public company has to stoop so low to get what it wants - that doesn’t speak well for its products. And hardly impressive of a plc to tell shareholders that it would maximise returns and pay dividends to trade on the Internet rather continue to drain profits by maintaining a ‘high street’ presence. Be that as it may, in effect, landlords are being asked to subsidise a retailer’s desire to have it both ways, even though others would pay more rent.

For landlords, a dilemma of recession is whether tenants should be helped to survive the error of (their) ways. I emphasise ‘their’ because something tenants are good at is making pronouncements about the market as a whole as if their experience should be considered the only barometer of consumer behaviour. Often, the facts are found amongst suppliers: for example, Hornby plc (toys) results in June 2010 said “it is now clear that our larger retail customers recognise that they failed to fulfil their sales potential in 2009. ”

Life has ups-and-downs, and a business plan is rarely straightforward, but we are not supposed to come unstuck in times of change. One factor to ponder is whether it should be reasonably assumed inherent, depending on the calibre of tenant, for the tenant to be expected to have what it takes to anticipate downturns in its market and prepare accordingly. That does not seem to be how the victim tenant thinks: for them, the business sector ought to be considered a special case: a sort of level playing field for all, regardless of the ups-and-downs of the economy. Landlords too have self-interest. The most important factor is whether a landlord can afford to be accommodating. How much rent and what terms can be varied very much depends upon when the property was bought, how much was paid, and how much was borrowed. It also depends on whether the tenant has a guarantor, because any material alteration to the terms of a contract which might potentially prejudice the guarantor will release him unless he specially consents to the variation, West Horndon Industrial Park v Phoenix Timber [1995] Although business tenancy law and rental valuation are not concerned with the wider consequences for the parties, psychology steps in to ask about the consequence for the landlord in the event of existing tenant default, such as whether the property would let in a fairly short time to a tenant of at least the same calibre, and at least the same rent; and whether on expiry the tenant in difficulties would renew for at least the same term as before. For a tenant, one reason for taking the route of insolvency, administration or CVA, is a consequence of alienation criteria that a landlord can include in a tenancy to reflect privity of contract: a tenant must consider the likelihood of finding a financially sound assignee. The number of tenants with the where-with-all to cope with slow trading is in short supply. An authorised guarantee agreement to sign, the tenant cannot afford the risk of a defaulting assignee.

The landlord should be mindful of changes to capital value that can be caused by tenant assignment and under-letting. The number of tenants whose covenant enhances value has been diminishing for years. Although a landlord may serve notice on a tenant for the purpose of protecting investment value, the timing of the notice is critical and the procedure little used. Generally, commercial property for investment is a depreciating asset, because the price paid rarely reflects the market value of the property alone, but includes the calibre of the tenant. Often, growth is illusory: although capital value is estimated by valuing on a date, investment performance should allow for inflation, loss of interest on equity, and holding and management costs, interest, tax on rent and any gain. Strip out those figures and whatever’s left is the real growth. Nowadays, maintaining investment value is just as challenging as increasing value. For example, an investment for 15 years with 5 yearly rent reviews will only maintain its capital value if at each review the rent goes up by enough to offset fluctuations in investment yields and what might happen on expiry. Where a landlord has been accommodating, at subsequent rent review and on tenancy renewal, the likelihood of a rent increase diminishes, because in personalising the landlord and tenant relationship, by focussing on the business for which the tenant chooses to use the premises, the landlord can get stuck with a dud tenant and the investment under-perform for the wrong reasons. Many tenants would have landlords believe that the property system should be changed to reflect the changes in the market, but equally many landlords think tenants should change their modus operandi to synchronise with the market. The property system is more flexible than many tenants would like to think, if only because landlords can be accommodating. The underlying difficulty for those tenants, and surveyors that have prospered on the success of those tenants - and whose loyalty is to those tenants - is that really the problem their clients face is not caused by any intransigence amongst landlords, but that the mass-market has entered decline and fall. It is the Age of Individuality. Alongside the dominance of supermarkets for convenience and free-parking, and a few clothing companies for garments, it is the specialist retailers that are thriving, along with the giants of the internet.

At rent review, a tenant has no control of the psychology because the tenancy remains vested in that tenant so the review guidelines, which are emotionally detached, are paramount but, on expiry, the tenant does not have to renew. A choice whether to renew only puts the tenant in a stronger position if the tenant could afford to relocate or close the business at the particular premises. Multiple retailers and big companies are in a stronger position to dictate terms on renewal because rarely is the performance of their business overall dependent on any one branch. For smaller businesses, flexibility is limited. Often the value or saleability of the business as a going concern is inextricably bound up with the premises and a secure term of tenancy. Ever since investment value strayed from property fundamentals to become dependent upon covenant of tenant, that dependency has been exploited. The banks have done a stirling job using sale-and-leasebacks to maximise capital proceeds, only to serve up branch closures for the next course. What price the building without its original occupier? An investor is buying the building, not the tenant and no structured rent review, such as index-linking, pre-fixed increases and compounding is going to make up for the fact the more the rent payable exceeds the market rent, the riskier the investment. In the shop property market, whilst the primary market that multiple retailers inhabit may not be providing much growth, the same cannot be said of the secondary market where there is often keen demand. The secondary market is not just about trading position, but also locality. Many secondary towns are more stable than primaries nearby, often because the Zone A rate is economical. In Ledbury, for example, the market town where I am based, and whose population is just under 10,000, demand for shops is buoyant and rents have gone up in the last couple of years. Another factor that those that think the world owes them a living would do well to remember is that commercial property often lends itself to redevelopment and reconfiguration, or simply disposal with vacant possession. One thing tenants should be careful of when testing the loyalty to the tenant’s cause is that the landlord might be thinking of using the opportunity to do something different with the building. In the balance of power, one principle remains steadfast: the property belongs to the landlord, so how the tenant extracts itself from the tenancy commitment must be honourable otherwise the course of action will back-fire on the tenant.

Without Prejudice

Last year someone on LandlordZONE Forum’s commercial property board was asking about breach of warranty of authority, and suggesting the landlord’s surveyor might be pulling a fast one. For further reading, please visit LandlordZone newsletter issue 17 - click here

Point of Law

In Shirlcar Properties Ltd v Heinitz & Another [1982], the Court stated stated that use of the expression ' subject to contract' did not constitute effective notice to set a rent review procedure in motion when formal notice had to be given. Use of the expression 'without prejudice' is widely misunderstood and so it comes as no real surprise to find that many surveyors are unable to grasp the effect of such wording when concluding rent review negotiations.

An offer made 'without prejudice' is binding if acceptance of the offer is made. By adding the words ' subject to contract,' however, the presumption that the parties intend to create legal relations may be expressly negatived. From Rose & Frank v ] R Crompton Ltd [1923], "the words of the preliminary agreement in other respects may be apt and sufficient to constitute an open contract, but if the parties in so agreeing make it plain that they do not intend to be bound except by some subsequent document, they remain unbound though no further negotiation be contemplated. Either side is free to abandon the agreement and to refuse to assent to any legal obligation .... "

When concluding negotiations, it is common for valuers to head the correspondence 'without prejudice' (and/or) 'subject to contract.' In such cases, the concluded rental will be subject to the valuer's recommendation of acceptance. This reservation in itself is sufficient evidence that no formal agreement has been reached, even if the recommendation refers to the need for 'Board approval' reckoned to be a formality. Until an offer is made without reservation, it is not agreed and some valuers and parties feel that withdrawal from the 'conclusion' is tantamount to unethical or unprofessional behaviour against the spirit of negotiation. Such opinion is, of course, the prerogative of the aggrieved party but it does not affect the legal position and, whereas such practice may conflict with expectations, valuers must recognise that the law applies as much to the interpretation of rent review covenants as it does to negotiations.