Understanding rent reviews in commercial leases and how to manage them

• Posted onDecember 19, 2024

Rent reviews in commercial leases are crucial for aligning rental income with market conditions. Cara Forrest Associate Solicitor in our Commercial Property Department share her insight into the types of rent reviews, common reasons for rent increases, and tips on managing the process. It also offers expert advice on negotiating and resolving disputes.

Understanding rent reviews in commercial leases and balancing interests

Rent increases are an essential part of leasing commercial property.  Periodic rent adjustments allow the Landlord during the term of a Lease to keep rental income aligned with the market and inflation.  However, for tenants, it can sometimes feel like an untimely financial burden.

At the outset when negotiating Heads of Terms for a new Lease, the rent review terms should be considered by the parties along with the negotiation of various other terms of the Lease.  For example, the parties can consider negotiating rent-free periods, service charge caps, flexible break clauses – potentially for the Tenant to have the ability to break the lease on an agreed date following the impact of a rent review.

3 circumstances can a landlord increase the rent?

Landlords cannot raise rent arbitrarily and specific clauses must exist in the Lease to enable a rent increase during the lease term.   The most common circumstances that justify a commercial rent increase during a lease sare as follows:

1. Lease Renewal: When a fixed term lease expires, the landlord may propose a rent increase when negotiating a Lease renewal with the Tenant.
2. Market Rent Reviews:  Leases can contain contractual provision for periodic rent reviews based on current open market conditions. If rents in the area have increased, the landlord may seek to adjust the rent upwards on a review date.
3. Index-Linked Increases: Many commercial leases include a rent review provision that ties rent to inflation, often through the Retail Price Index (RPI) or Consumer Price Index (CPI). These rent increases are calculated at specified rent review dates during the Lease.

What are the different types of rent reviews in commercial leases?

There are various mechanisms Landlords can use to review rent during a Lease term, each impacting how and when the rent can be adjusted. Understanding these can help both landlord and tenant negotiate at the outset which type of rent review works best for them and to anticipate and prepare for potential rent increases.

1 Open Market Rent Review: This type of review adjusts rent to reflect current open market conditions taking into account standard commercial ‘assumptions’ and ‘disregards’ which are to be considered on the rent review.  The parties can mutually agree the revised rent however often a professional valuation is required to assess comparable rents for similar properties in the area.  In the event the parties dispute the revised open market rent, the lease should contain a mechanism to refer the review to an independent expert mutually appointed by the parties to make the final decision.

These open market rent reviews are often described as ‘upwards only’, as on review the revised rent will be the higher of the previous rent payable before the review date and the revised open marked rent – therefore the rent payable will never fall before the starting rent in the Lease.

2 Index-Linked Review: This ties rent increases to a specific economic indicator, typically the RPI or CPI. The rent automatically adjusts according to changes in these indices on the agreed rent review date(s) in the lease.

It is crucially  important to ensure the drafting of the rent review formula correctly reflects what the parties intended to agree.  Ambiguity can often arise as there are generally two ways of drafting a RPI rent review formula:

• EITHER the % change in the Index is applied to the initial lease rent – so each year the formula takes the initial rent and applies the % change in the Index since term commencement;
• OR a % change in the Index is applied to the current rent – so each year the formula takes the current rent and applies the % change in the Index over the previous year.

The danger is that these 2 formulas can get muddled up, which produces a ratcheting effect with an inflated rent and a windfall for the landlord.    It is therefore key to check the formula with worked example rental figures – to be sure that the formula doesn’t produce an unintended consequence on future rent reviews.

RPI / CPI  rent reviews can also be drafted to include a ‘cap and collar’ mechanism, which sets a  maximum and minimum increase on each rent review.   For example, a collar of 2% and a cap of 5% ensures the rent on review will always increase between 2% and 5% per annum, even if the relevant index has increased by more or less than those figures.

3 Stepped Rent Review: The Lease may be drafted to include pre-agreed rents increasing at specified intervals during the Lease. The advantage of this is to provide predictability of the rent payable for both the tenant and landlord when entering the Lease, however such agreed stepped rental increases may not then transpire to actually be reflective of changing open market rents or inflation.

4 Turnover Rent Review: It can be common in retail commercial leases to link rent increases to the tenant’s actual turnover.   These rent increases are intended to be proportionate to the business’s income, which can be favourable for businesses during tough financial periods and for businesses operating from multiple stores.    It is however important to understand the component parts of ‘turnover’ which are to be reported by tenants in calculating the store’s turnover, e.g. till sales, online sales, click and collect, concession income etc.   It is also necessary to clarify how, for example, sales returns originating from one store / online are dealt with at a particular store as well as sales not remitted in full at the point of sale through use of gift/loyalty cards etc.

Can a tenant challenge a commercial rent increase?

Tenants can challenge a rent increase however how this process is dealt with will largely depend on the type of rent review clause in the Lease and the specific lease terms set out in the Lease around rent review.

• Review the Lease Agreement: The first step is to carefully review the rent review clause in your Lease. If the landlord is proposing an increase outside the terms of this clause, the tenant may have valid grounds to challenge it.
• Request a Valuation: In the case of an open market rent review, the parties can seek an independent valuation from a professional qualified surveyor which can be used as evidence to negotiate the proposed rent increase.
• Professional Recourse: If negotiations between the parties fail, tenants may need to refer the dispute for Expert determination pursuant to the Lease terms or take legal advice.  Commercial leases usually provide for rent review disputes to be referred for arbitration or mediation in the first instance.

Can a tenant negotiate a rent increase?

Yes, there are various ways a Tenant can seek to negotiate an upcoming rent increase with their Landlord:

• Start Early: Both parties should engage in discussions well before the rent review date. This shows a proactive approach and allows sufficient time to gather suitable evidence in relation to the proposed rental increase before the review date.
• Provide Market Evidence: Research similar properties in the area and provide evidence to justify why as tenant you feel the proposed rent increase is above the current open market rate for the locality of your property.
• Consider Your Long-Term Plans: Landlords may be willing to negotiate a more conservative rent increase on review if the Tenant agrees to extend the lease (by entering into a new Reversionary Lease) and therefore commits to a longer occupation.    This gives the landlord a further guaranteed period of income and provides the tenant with security they can remain in the property after the term of their existing lease expires.

Negotiation is about finding a mutually beneficial agreement for both parties taking into account the prevailing market conditions and also the long terms plans of both parties.

Proactively managing rent reviews in commercial leases

The presumption is that time is not of the essence in rent review clauses unless the lease specifically states otherwise – which is very unusual in commercial leases.   Commercial leases will most likely state that time is not of the essence in a rent review clause to ensure there is no room for ambiguity.

Where time is not of the essence, the ability to review the rent payable will generally remain for as long as the lease is in existence including any period of holding over under the Landlord and Tenant Act 1954. Once the lease comes to an end, the general view is that the landlord will then lose the right to initiate a retrospective rent review as the contractual relationship between the parties has then ended.

If the revised rent is not agreed on or before a review date, the tenant will continue to pay the current rent until the new rent is agreed.  The tenant is generally then required to pay any shortfall arising following a rent increase retrospectively from the actual review date until the date of payment  – with interest payable on that shortfall.

It is therefore advisable to be proactive and agree the revised rent in advance of the upcoming review date.

How WSP Solicitors can help you?

WSP Solicitors brings a wealth of experience and a client-first approach to ensure that both landlords and tenants can navigate the complexities of commercial leases and rent reviews successfully.

Rent review increases are inevitable in commercial leases however it is important to find the right mechanism which works for you.

Whether you’re a landlord or tenant seeking to agree a suitable rent review mechanism for a new Lease or if you are in need of guidance with interpreting an existing rent review, WSP Solicitors can offer expert guidance and practical solutions:

• Lease Advisory Services: WSP offers a comprehensive lease advisory service to help draft, clarify and advise upon complex lease clauses.
• Dispute Resolution: Should a rent dispute arise, WSP can advise upon property dispute and litigation matters.
• Practical Solutions for Both Parties: WSP regularly advises both landlords and tenants and, whilst understanding the needs of both parties, we seek to strike a commercial balance in our lease drafting which is fair and reasonable and moves the transaction forward.

To enquire today please get in touch. You can call our Gloucester office  on 01452 898727 or the Stroud office on 01453 383985 or you can email us on  contact@wspsolicitors.com. Alternatively you can use the enquiry form on the side of the page.