Open Market Rent Reviews

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Often commercial leases contain rent review provisions which are intended to determine the amount of rent payable at various stages during the life of a lease. The frequency that a rent review occurs can vary per lease as it will depend on what the lease stipulates, however a rent review period every 3 or 5 years is quite common among commercial leases.

There are different ways in which a rent review can take place, the most common of which is an open market rent review. This enables the rent to be set in accordance with market conditions at the time of the review, i.e. in line with other rents being charged on similar properties in similar areas at the best rate the property could receive. With that said, often the rent review provisions will only allow for an increase in rent. Therefore, it is likely that at the time of the rent review the rent will either remain the same or increase depending on the market rent at the time. Whether the rent can decrease is largely dependent upon the bargaining positions of the parties when negotiating the terms of the contract. Ideally for the tenant a provision that the rent can go up as well as down will be more favourable, however this is not very common and is only likely to occur during times of economic downturn.

The most effective way to assess the open market rent is to have an expert assist the parties. Often the parties will appoint their own surveyor to decide on the open market rent and help them with the negotiations of the new rent to be paid. Although this will incur an additional cost this is more cost effective than proceeding by means of litigation. In the event that an agreement of the new rent cannot be reached between the parties the lease should state how this will be resolved. They may appoint experts or arbitrators to assess the new rent, which will then be binding on both parties. In the event of a dispute the current rent will be paid which will then be backdated once the rent has been determined. The more frequent the rent reviews, the greater the costs particularly where an agreement cannot be reached.

When deciding on the open market rent the expert will consider comparable properties to arrive at the value of the new rent. In order for this to be determined the expert considers the concept of the ‘hypothetical lease’. The hypothetical lease is a mirror of the actual lease with assumptions and disregards being made in relation to the letting in question. If the surveyor was instructed to value the open market rent based on the actual property it could lead to an unfair valuation, for example if the property was in poor condition due to the tenant failing to comply with repairing covenants which would reduce the valuation in the open market. Therefore, the assumption would be made that the tenant has complied with their covenants at the time of the valuation. The lease will also make disregards when it comes to the assessment of the new rent, for example if the tenant has built up good relationships and goodwill among its clients in the area (making the market value inflated) then this can be disregarded on valuation. The same applies where the tenant has made improvements which can also be disregarded. Therefore, taking the hypothetical lease into account the open market valuation will be determined by the expert.

When it is time for the rent to be reviewed, this procedure can be commenced by notice or by the parties entering into negotiations. Often the lease will state that the notice must be given in writing. Even if it doesn’t, the Law of Property Act 1925 section 196(1) requires a written notice or counter-notice. The lease may also outline if the notice needs to be in a particular format.

To minimise the risk of delay and expense when the rent is being reviewed, both the landlord and tenants ought to seek legal advice and ensure that they are fully aware of the rent review provisions of a lease and that time it taken to carefully negotiate those provisions on the grant of a new lease.

 

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