‘Open-market' rent reviews
It is a good idea to plan for your rent reviews and to consider your tactics so as to achieve the best result. Legal expert Debra Kent discusses the "open-market" form of rent review.
THE PROBLEM
The rent for restaurants and cafés is usually fixed for a five-year period and is then reviewed to "open-market value". Hotels and some other leisure operators have more unusual rent review provisions where rent may be decided by reference to the Retail Prices Index, stepped rents, bed occupancy or some other measure.
The open-market rent review is usually upwards only: the rent does not go down, even if the rent payable in the open market is less! It is important to make sure your lease covers the situation properly so that there are no nasty surprises.
THE LAW
The lease will set out the basis of the rent review. The task is to work out what a tenant will pay in rent for a hypothetical lease of the property which is substantially the same as the existing lease - with some additional assumptions and matters to ignore ("disregards").
Even straightforward rent review clauses can be complicated.
EXPERT ADVICE
One example of this is break clauses: what happens if a tenant has a right to terminate his 15-year lease at year five, but does not do so? Should the rent review at year five assume that the tenant has a 10-year lease with another five-year break right when actually that right has expired?
Tenants would argue that as there is no further break right in reality, none should be in the hypothetical lease. The landlord will want to assume the break right still exists - so that there will be an increase in rent attributable to this advantageous right.
The length of the hypothetical lease is usually the greater of the time left on the lease or a specified minimum period - often 10 years. Depending upon market conditions, this can either increase or decrease the likely rent at review.
Generally, if the tenant had a rent-free period at the beginning of the lease, or the landlord made a contribution to fit-out costs, or there was some other benefit to encourage the tenant to take the lease, these personal benefits are ignored at a rent review.
However, any inducements offered generally to tenants looking for properties at the review date should be taken into account. Otherwise, the landlord would achieve what is called a "headline" rent - something significantly larger than the real rent genuinely available in the property market at the time.
The effect on rent of the goodwill of the business carried out at the property is almost always disregarded, which means tenants won't pay again via the rent for the goodwill.
Also, the tenant's works are usually ignored when looking at a new rent. However, if the landlord paid for any alterations, it is common for them to be taken into account in the new rent.
CHECK LIST
• Check the review clause and lease.
• Retain a surveyor to advise on comparable rents.
• Seek legal advice on the effect of the lease wording.
• Make sure any works you carry out are disregarded at rent review.
BEWARE!
Some leisure properties are unique or unusual. There may be no similar properties to compare it to when deciding the open-market rent.
When McDonald's introduced its first UK drive-through restaurant the lease required that rent was to be reviewed as if the restaurant was a warehouse. Following a dispute over the wording, the court decided that the imaginary warehouse could effectively be used as a retail shop, which attracted a higher rent than a plain warehouse. This was an unintended consequence of ambiguous wording and not what McDonald's had wanted.
Fairly minor changes to the wording of review clauses can have unacceptable results for either the landlord or the tenant.
CONTACT
Debra Kent, partner
Charles Russell
