Could this really be the end of the upward only rent review?

Upwards-only rent review (UORR) clauses, are a common feature of leases of commercial property, and as the name suggests, mean that a rent for the term of a lease will only ever increase. An UORR will usually result in the reviewed rent being the higher of (a) the market rent at the date of the review or (b) the rent that was being paid at the rent review date. Understandably, landlords like an UORR. Tenants are not so keen. UORR can result in the tenant paying rent that is far higher than the current market rent, resulting in significant financial burden.

Over twenty years ago, the then Labour government, consulted on the options available to end certain leasing practices and this focused principally on UORR clauses in commercial leases. Whilst that consultation recognised both the advantages and disadvantages of an UORR, the resounding response to the consultation in 2005 was against legislating a ban on UORR.

Last week saw the publication of The English Devolution and Community Empowerment Bill. Whilst the Bill seeks to deliver on the government’s manifesto pledge to de-centralise power and develop regional growth, hidden at Part 5 and Schedule 31 of the Bill, are significant provisions that will ban the inclusion of UORR clauses in all new commercial leases (and leases that undergo statutory renewal) (see our article An interim update on security of tenure for our latest thinking and interim update on security of tenure) once the Act is in force. The Bill provisions have certainly caused a stir in the last few days, and it will be interesting to see how the property industry continues to react.

The government says the Bill will include “Banning Upward Only Rent Reviews (UORR) clauses in commercial leases, which pit landlords against businesses and can make rents unaffordable and cause shops to shut. This will help keep small businesses running, boost local economies and job opportunities and help end the blight of vacant high streets and the unacceptable anti-social behaviour that comes with them”. In our articles On the second day of Christmas, the government took from me…the power to rent high street property and  High street recovery – high street rental auctions (HSRA’s)  we reported on the regulations and whether usage by local authorities was gaining momentum. The abolition of UORR is the next step along the path of the government’s aim to “breathe new life back into high streets”.

The explanatory notes to accompany the Bill, identify that existing legislation does not set the framework for rent review provisions in commercial leases. The provisions of the Bill, as drafted, will insert a new section to the Landlord and Tenant Act 1954 and will provide the currently absent definition. The provisions will apply to all business tenancies (falling within the parameters of Part II of the 1954 Act) that contain rent review clauses. The provisions will mean that whilst rent reviews can be indexed or market rent linked, those indexes must be able to move both upwards and downwards.

While the provisions introduced by the Bill are intended to improve our country’s high streets and support small businesses, their application will extend to all commercial business tenancies, including warehouses and offices and it is questionable whether they will truly deliver on the goal of reinvigorating our high streets, given that many high street tenants are in fact on shorter tenancies. It remains to be seen how the market will respond and adapt to this change.

Leases with fixed stepped rents might become more commonplace but they can be less adaptive to prevailing market conditions. Index linked rents with a cap and collar are often used to give both landlord and tenant some certainty, but without the guarantee offered by a minimum increase, landlords may not be willing to offer a cap.  Along with an increase in stepped rents, we could also see increased use of index linked rents (as in practice it is rare for CPI or RPI to decrease) or a move away from rent reviews altogether. Meanwhile, the trend of shorter lease terms will likely continue.

The Bill is of course a considerable way off becoming law and will be subject to amendment and refinement as it makes its way through Parliament over the coming months. Secondary legislation is expected and there will be a raft of consultation and debate to follow. If, however, the Bill were to remain as drafted, landlords will have a limited choice. Offer a fixed rent for the term of the lease, or alternatively, a rent review that may go up or down and that is indexed linked or in line with the market.

The Bill has certainly taken the British Property Federation by surprise and there are concerns that the Bill will have a negative impact on investor confidence and tighten the supply of suitable properties, which ultimately could increase rents in some sectors. The Bill will overhaul the lease negotiation process as between landlord and tenant, not just in respect of the rent review provisions to be included in a lease but will likely fundamentally change other major provisions of a commercial property lease and the terms that a landlord is prepared to offer. In the coming months, it is likely that tenants may hedge their bets and seek to capitalise on the uncertainty the publication of the Bill has created, and ask for more favourable rent review terms now, ahead of any changes that may later come into force.

For property investors and landlords, the implications are potentially serious. There may be a reticence by landlords to deploy capital in the short term until there is greater certainty as to how the market will react.  This could delay significant capital expenditure projects across landlord portfolios, including those required to comply with other regulatory regimes, notably the Building Safety Act and The Minimum Energy Efficiency Standards Regulations or for long-term placemaking. 

As the Bill progresses through Parliament, we will be keeping a careful eye on its development, together with the outcomes of the market and industry body consultations so that our landlord and tenant clients can best prepare for the changes that may be on the horizon. The second parliamentary reading of the Bill is likely to fall after the summer recess.

This article was published in the July edition of Property Perspectives.

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