By Michael Large of Colman Coyle
Michael Large is a Senior Associate Solicitor at Colman Coyle Limited, a member of the Guardians of the Arches Advisory Board, and lectures on rent reviews for the Royal Institution of Chartered Surveyors (RICS). If you would like to contact him regarding any property law issues call 020 7704 3425 or email michael.large@colmancoyle.com
Dear Member
The Guardians’ have asked me to prepare a guide to the world of rent reviews, which are the number one issue facing the membership at the moment.
There is an awful lot to get through so I am going to break it down into ten bite-sized chunks for you to read through in the coming weeks. Whether you are a veteran or a newcomer I hope there will be something for you here. If you can’t wait that long, call me or the Guardians for a chat.
Are you sitting comfortably? By the end of this series you will probably be about as comfortable as Dustin Hoffman strapped to that dentists’ chair in Marathon Man.
Rent reviews – are they safe? Sit back, this won’t hurt a bit…
Part One- What is a rent review?
A rent review is a mechanism in a lease contract where after a certain period of time the landlord can adjust the rent. In most but not all railway arch leases this is every three years. In most but not all railway arch leases the ‘adjustment’ is ‘upwards only’. That means it will at best stay the same. Even if the market rent has decreased or crashed through the floor. Most likely though the rent will go up. Many arch tenants as you will know are facing huge increases.
The procedure for doing this and the way the rent is calculated is set out in the lease. I will deal with that in detail in another post in this series. That is the crucial bit.
A ‘review’ of the rent will also take place when a lease is renewed under the Landlord & Tenant Act 1954. Those ‘statutory’ rent reviews, unlike contractual rent reviews, can be upwards or downwards. I will deal with those in another post. These are a lot more tenant friendly and if that option is open to you, it is worth considering.
There are many types of rent reviews in commercial leases, but most railway lease rent reviews are ‘upwards only, open market’. We know what upwards only means now, but ‘open market’ is a very loaded phrase. It means different things to different people – the landlord thinks it is high, the tenant thinks it is low. How we reach a ‘market rent’ is a matter for a huge amount of argument, with your money at stake and riding on it.
Part Two: Starting the Rent Review
A rent review isusually kicked off by written notice. How does it work?
At some point you will get a rent review notice in the post. It will tell you what rent the landlord is proposing. You need to respond to that within the time specified by the lease. Railway leases usually say 28 days or a month, but check carefully. When this happens you need to act FAST. If you miss the deadline then the new rent is fixed at whatever was in the landlord’s notice. You snooze, you lose!
If in doubt, get professional advice fast.
You need to reply with your own written ‘counter notice’ that you don’t agree with the landlord’s proposed rent, and respond with your own. Usually it is safe to propose a nil rent increase. There may be other requirements in the lease as to what you have to say, so check it carefully. It is unlikely you are required by your lease to provide your own evidence about rent, even if the landlord asks you to in their letter, with your counter-notice.
Go with the date on the landlords’ notice NOT the date you think you received it to work out your deadline. You need to get the counter-notice back to the landlord before your time is up. The rules on service usually provide that it is deemed to take place a couple of days after you send it. So don’t wait until the last day, get it done asap. Use recorded delivery post and send another copy in the ordinary post as a back up. Email is not good legal service for this unless the lease says so, and it almost certainly won’t. If you just email it your counter notice will be invalid. Send an email as well if you like.
NEVER, EVER send a counter-notice that is “without prejudice” or “without prejudice save as to costs”, or “subject to contract”, or that has those words anywhere in it. That will invalidate it. I am not going to quote loads of cases in this series, but because people ALWAYS argue about this point, see Maurice Investments Ltd v Lincoln Services Ltd [2006] All ER (D) 402)
If you get your counter-notice done in time, you are protected for the time being. You and the landlord now need to try to negotiate a new rent. If you can’t manage it, then either of you can apply for a third party to be appointed, usually an arbitrator, to decide.
Part Three: Calculating the Rent: Comparables
Comparable evidence is (according to the RICS, and they should know) at the heart of rent reviews. A comparable is an item used in the valuation process as evidence. In a rent review arbitration (or valuation) the arbitrator will look at prices for a similar item in the market and assess it. This is a tricky business, an art as well as a science, and exactly how it works is beyond the scope of a short post like this, but I can give you the general idea.
So, bluntly, if the arch next door is the same size, and has the same lease, and the landlord tells you they are paying £100,000 a year, then maybe you might expect to pay £100,000 a year, too.
Or would you?
In assessing comparable evidence, this should ideally be (again, according to RICS):
- Comprehensive – a large number of transactions and not simply a couple – the more the better
- As similar as possible to the arch being value
- Recent
- An arms’ length open market transaction
- Verified
- Consistent with the local market practice
The market for property and indeed arches throws up a number of interesting issues and problems (and by interesting I mean potentially expensive):
- Comprehensive – a large number of transactions and not simply a couple – the more the better.
What if in my example next door was paying £100,000 but everyone else in the run was paying £50,000? What if there are fifty relevant comparables but the landlord only lets you see two or three of them? Which ones do you think the landlord is going to show you?The expensive ones or the cheap ones?
- As similar as possible to the arch being valued
What if next door has access problems, or disrepair?
- Recent
What if my example was from ten years ago, and rents have gone down – or gone up – since?
- An arms’ length open market transaction
What if my example was a default rent review? Where the tenant had failed to serve a counter-notice in time? See last week’s post. None of you will be falling for that, of course!
- Verified
Did it really happen? Was it a real transaction on those terms? Or was there a side letter or some other factor?
- Consistent with the local market practice
What if a big chain moved in, money no object, and paid the £100,000, but everyone else in the run was paying half that? Is that consistent with local market practice?
The main problem in this market for railway arches is one of transparency. There are a couple of big landlords involved and they hold all the evidence – all the comparables. If you have all the information, then dodgy comparables are going to stick out like a sore thumb. It is all about getting as much relevant information as possible.
How do you get hold of the comparables for your rent review? It isn’t always easy, but there are a number of ways. Rent review surveyors can get access to various databases and evidence. Another way is to share information with your neighbours, or fellow Guardians members!
I’m sure that there will be endless arguments about this, but, really, what is the argument AGAINST having fairness, openness and transparency in the commercial rental market?
Part Four: Calculating the Rent: Assumptions and Disregards
On a rent review, the new rent is calculated by reference to a set of “assumptions”. A number of factors are also “disregarded”.
A typical railway arch lease will have a rent review clause like this:
“Assumption” :
* willing landlord and a willing tenant
* have regard to the terms of the tenancy other than those relating to rent
* assume that all tenant obligations have been performed and that any destruction or damage has been made good
* assume the property is vacant and to let
“Disregards”
* disregard any goodwill since the tenancy start date due to your business
* any improvements the tenant did not have to carry out under the terms of the tenancy or under any other written agreement with landlord
These reviews are of course “upwards only”.
The property will be accordingly valued in its existing state of repair, “disregarding” disrepair resulting from any breach by the tenant of repairing obligations.
Your precise lease terms may differ and you need to check your lease, but most are on these lines. Clearly the advice here is to get professional assistance from a surveyor on these issues. But here are a couple of suggestions and tips for you:
– if there are many vacant arches locally, because prices are so high, can you make a case that this is not a “willing landlord”?
– consider access issues: if access is bad that should have an impact on rent
– if you have carried out improvements, do you have any evidence that the landlord authorised them?
– discount for bulk: like any other purchase you should really get a discount where you are buying a lot; it is your lease you are valuing, not “arches”. If your lease is for multiple arches you would not be expecting to pay the same rate per square foot as would be payable to lease a single arch. It should not be a matter of simply taking a base square footage and multiplying the number of arches.
– mezzanines: this is a tricky one, but there is an argument that the price per square foot includes an element of height already: a higher arch will in general have a higher price than a low one, because you can do more stuff with it. Arguably, if you have a mezzanine, then you should not be paying for that as well because the mezzanine is already “priced in” to the square footage.
– on the converse side, the low bits of arches (where they curve down) should be priced lower, especially where the height is under 1.5metres. You should not necessarily pay the same square footage throughout. Some areas of the arch will have a higher value than others – some may have little or no value at all!
– finally, on mezzanines again, a mezzanine should not be attached to the arch structure (without permission). Assuming it is free standing (which most are) then arguably it is a tenant fixture anyway not an improvement. The argument would run that it should no more be rentalised than a desk should be.
Again, all of these are really points to consider in conjunction with professional advisors, but I hope they will give you some food for thought and some negotiation tools.
Part Five: Calculating the Rent: 1954 Act Lease Renewals
If you have a protected tenancy and are going through a statutory lease renewal, then part of the process is fixing a new rent. The Courts use Section 34 of the Landlord & Tenant Act 1954 (“LTA 1954”) to calculate (or rather value) the new rent. So Section 34 and not the rent review clause in the lease will apply. Crucially, Section 34 is not ‘upwards only’ and can go down as well as up!
Section 34 provides that:
“Assumption”: “the rent payable shall be what the holding might reasonably be expected to be let in the open market by a willing lessor, there being disregarded—”
“Disregards”:
- any effect on rent of the fact of the tenant (or predecessors) having been in occupation of the premises (good or bad!)
- tenant goodwill
- improvements carried out by a person who at the time was the tenant, but only if carried out otherwise than in pursuance of an obligation to the immediate landlord and during the current tenancy or not more than twenty-one years ago
- any addition to its value attributable to the licence for licenced premises
- any effect on rent of the operation of the provisions of the Landlord & Tenant Covenants Act 1995 (Section 34(4) LTA 1954)
- the Adjudicator/Court will generally assume vacant possession.
The property will be valued in its existing state of repair, “disregarding” disrepair resulting from the tenant’s breach of its repairing obligations.
Unopposed lease renewals in the greater London area are now dealt with by the First-Tier (Property) Tribunal (FTT). This is a quicker and more streamlined procedure. The FTT aims to barrel its way through renewals in three months. It is likely to be better for tenants than the old slog through the County Courts, which could take years.
Part Six: Rent Review Dispute Resolution
Rent review disputes will be resolved by the following methods:
- Adjudication (Arbitration / Expert Determination)
- Unopposed Lease Renewal Proceedings under Landlord & Tenant Act 1954
- Professional Arbitration on Court Terms (PACT)
- Without Prejudice negotiations and offers (which I will cover in Part Seven).
Arbitration Leases usually provide for rent reviews to be referred to President of the Royal Institution of Chartered Surveyors (RICS) who will appoint an Arbitrator. The process is confidential and flexible. The award is binding and enforceable through the Courts. An award can only be challenged on limited procedural grounds (fraud, procedural irregularity, etc) and within 28 days.
Expert Determination Expert Determination is less common than Arbitration. The expert’s terms of reference will set out the matters in dispute and the experts powers and duties. There are limited procedural grounds for challenge and no ‘appeal’.
Lease Renewal Unopposed Lease Renewal Proceedings under the Landlord & Tenant Act 1954 are usually in County Court and include a “rent review”, determination of a new rent under the LTA 1954. “Interim rent” liability arises from the earliest date that could have been specified in the statutory notice – so in effect it the “review date” is backdated to that date. Valuation is on the basis of Section 34 LTA 1954 (see Part Three).
Professional Arbitration on Court Terms (PACT)
The parties to a lease renewal can agree to have the rent determined under PACT. This is not compulsory. Despite the name the parties can agree expert determination rather than arbitration if they agree.
Part Seven: Rent Review Negotiations– without prejudice negotiations and offers
‘Without prejudice’ communications are a genuine attempt to resolve a dispute and are legally privileged. These can be letters, emails, telephone discussions, meetings, and/or mediations. Anything intended to be ‘without prejudice’ should be clearly labelled, although the label is not definitive.
The correct heading for such correspondence is ‘Without Prejudice Save as To Costs’. This will enable it to be referred to later on the question of costs either by the Arbitrator/adjudicator or by a Court. Anything marked simply ‘Without Prejudice’ is likely to be inadmissible on costs. If accepted, such an offer can be legally binding (so it may be a good idea to mark it ‘subject to contract’ in some circumstances).
Labelling a rent review notice or counter notice “without prejudice” or “without prejudice save as to costs” or even “Subject to Contract” will probably invalidate it.
Dispute Resolution: Offers to Settle
Offers will normally be without prejudice save as to costs. You can make an “open” offers if so advised, although these are unusual in the rent review context. In non-rent review cases the Courts in are increasingly keen on open offers.
Rent review offers are likely to be “Calderbank” offers, that means made in accordance with the case of Calderbank v Calderbank [1976] Fam 93. This covers any genuine settlement offer and is flexible to the extent it can contain whatever you want. On the other hand, the Judge/arbitrator has wide discretion as to what weight to give it on costs, if any.
Part 36 Offers
Part 36 Offers are more formal. There is a self-contained costs code in Part 36 of the Civil Procedure Rules setting out the technical requirements. The benefits of making a Part 36 Offer (and doing better than it) are that the Court can impose costs and interest penalties on the other side, and even potentially an uplift on damages.
Arbitration and Part 36 Offers
CPR 36 applies to the Courts, not arbitrations. We suggest, where appropriate, best practice is to follow Part CPR 36 by analogy. There is no obligation to do so. The Arbitration Act 1966 (at Sections 61 to 63) gives the arbitrator a wide authority to set costs,
In both Court and Arbitrations, the usual rule is that costs follow the event i.e. loser pays!
Part Eight: Extreme Delay and Undead Rent Reviews
Extreme delay probably will not stop a rent review. There is no statutory limitation on them. Some ‘undead’ dormant reviews can lie dormant for many years, waiting to bite. How long can the landlord wait before they strike?
Eighteen months? Three and a half years? Eleven years? Thirteen years?
All of these have been accepted by the Courts in reported cases. The longest I have dealt with was triggered after seventeen years and the longest I have heard of anecdotally was triggered after thirty years. “Mere delay, in and of itself,” does not disentitle the landlord from instigating the rent review. Only if the lease says that time is of the essence for starting a rent review will there be a chance of it being disallowed. I have yet to see an arch lease that said so!
It was suggested by the High Court a while ago that a tenant could serve a notice making time of the essence if the landlord didn’t take any action. That has been found to be wrong. If you want to have a go at that, by all means do so but be warned it has no legal force.
What you can do is:
* notwithstanding the above, you might consider chasing the landlord
* put aside funds for the evil day when the review does take place
* get in touch with Guardians and see if they can help to put some pressure on
What should buyers of existing leases do? I t would seem reasonable to assume that a dormant rent review is unlikely ever to die, but continues in an ‘undead’ state indefinitely, waiting to bite someone. A nyone buying, guaranteeing, or taking on a lease should ask for evidence of the outcome of rent reviews. Where a review is outstanding (no matter how long ago) the buyer should ensure that the contract makes provision for the seller/assignor to contribute to the top up payment, if the review ever takes place. The seller/assignor may want the power to be involved in the rent review process to protect its interest. Standard Commercial Property Condition 5 deals with this issue if the rent review has started but is not finished (the Mastermind clause, if you like). However, where the rent review is lying, in an ‘undead’ state, dormant and waiting to bite, a special condition will be needed.
Part Nine: ‘How not to do it’ – when reviews go wrong!
We are all human and we all make mistakes… here are two examples of ‘how not to do it’ from rent reviews that we can all learn a lot of lessons from. Neither the writer nor Colman Coyle were involved in either!
These both involved lease renewals in court (which often are reported) rather than arbitrations (which are not generally reported) but the principles are still good for courts and arbitrations.
Market Evidence
In Flanders Community Centre Ltd v Newham LBC [2016] EWHC 1089 (Ch) Newham granted Flanders a lease for one pound (!) per year (plus insurance) on the condition that works were carried out. Flanders applies for a new lease under the Landlord & Tenant Act 1954. At Trial, a new tenancy was granted at the passing rent, one pound per year (plus insurance). A bit lower than the £16,000 the landlord wanted. The landlords appeal failed. The appeal court considered that trial is not a “dress rehearsal” – you have to get it right on the day! Errors made by both parties at trial could not be remedied on appeal. The Judge was entitled to find the comparable evidence unreliable as terms of allegedly comparable leases were not available. Evidence of what the tenant could afford was irrelevant, but the passing rent was accepted as a relevant factor. That was really the crucial factor: without much else to go on the judge was entitled to give a lot of weight to the passing rent. Which was £1.
Sham transactions:
Clear Call Ltd v Central London Investments Ltd [2016] EWCA Civ 12 , was a lease renewal under the Landlord & Tenant Act 1954. At trial, the tenant alleged that one of the landlord’s rent comparables was a sham because the premises was empty for sixteen months after the lease was granted. The tenant lost. On appeal, the tenant tried to rely on new evidence that the property was still unoccupied, and the tenant of the comparable property was a non-trading company. The new evidence failed to help: the fact that the comparable property continued to be empty added nothing if the trial judge had accepted it. The evidence about non-trading was not in fact new: it could have been used at trial, but was not. As in Flanders , trial is not a dress rehearsal – you have to get it right first time.
So if you have some juicy evidence, you should use it! And if you need some, get advice to help you uncover it.
Part Ten: Turnover Rents
Turnover leases are a way for the landlord and tenant to share the benefit (and risks) of the tenant’s business. Turnover rent is common in the retail sector and normally based on tenant’s turnover at the premises, and usually calculated as a percentage of profit or production at the premises. The rent may be purely based on turnover or there may be a basic rent payable in addition to the additional “turnover” rent.
There are high compliance burdens in relation to SDLT (Stamp Duty Land Tax) on turnover rent leases. Although these newsletters do not deal with tax, these leases can present special difficulties for calculating SDLT.
The tenant will have to demonstrate the ‘turnover’ to the landlord. If the tenant has more than one property, that might require a separate set of accounts per property. Then there are the specific problems created by this digital age we live in. Should online sales, the collection of goods, multi-channelling, and the like, count towards a turnover rent? What if a customer views an item in a shop but buys it on the way home, by ordering it on their mobile phone? All these are potential areas for dispute. High turnover, of course, may not equal high profit.
The landlord will not want to be left in a position where the tenant is making no income. Many landlords had an issue with letting pitches to newspaper vendors with rents based on the number of newspapers sold. A few years ago, many newspapers switched to being handed out for free – a real headache for landlords trying to calculate the turnover rent. The headache for tenants of course is the increased administration involved in turnover rents, and the potential tax issues. Another downside if you are the tenant is that rents locally could be going down, but because your business is a success, you are paying more rent!
Commercial Rent Reviews: a step by step guide: Part Eleven – Bonus!
GLOSSARY: RENT REVIEWS
A guide to common terms used in rent reviews
These are the terms most commonly used in rent reviews. Please note that these are not strict ‘legal’ definitions, or indeed ‘Red Book’ definitions*. These are intended for the ordinary person to get an idea of what a rent review involves.
*Red Book is defined below!
Arbitration: most leases provide that a surveyor (an ‘Arbitrator’) will adjudicate the review in default of agreement.
Assumption: set of assumptions on which the new rent is to be calculated. These may or may not match the reality on the ground!
Best rent: may or may not be the same as ‘market rent’, depending upon the lease wording.
Comparable: a property that shares characteristics with the subject premises, so that its value can be used to form an opinion of the rental value.
Disregard: a fact or thing to be ignored when deciding the rental value of a property.
Ground rent: low or nominal rent, usually paid under a long lease granted in return for a premium.
Headline rent: rent paid after the end of any rent-free or reduced rent period.
Market rent: the best rent that could be obtained in the open market for the property. Same meaning as ‘market rent’, ‘open market rent’, ‘best market rent’ and ‘rack rent’.
PACT: Professional Arbitration on Court Terms. An agreed reference by the parties to an adjudicator during a lease renewal under the Landlord & Tenant Act 1954.
Peppercorn rent: token or nominal rent.
Rack rent: usually means the market rent.The very best obtainable: “stretched” to its limits.
Red Book: The RICS Valuation, Global Standards 2017, contains rules and practice statements for all Chartered Surveyors who undertake valuations. Rent reviews (as well as other forms of valuation) are made in accordance with it.
Rent-free period: period of grace, usually at the start of a new lease when no rent is payable. Often agreed when the incoming tenant fits out premises.
Rent review memorandum: the revised rent agreed should be recorded in writing and kept with the lease.
Review date: the date when the reviewed rent is payable from.
Valuation date: when the new rent is valued. Usually, but not necessarily, same as the review date.
Without Prejudice Save As To Costs: privileged communications for the purpose of negotiation.
Barrelage: Used to be common in pub leases and is, in effect, an old form of turnover rent. (What is a turnover rent? See Part XII) The rent is linked to the number of barrels of beer drunk.
Indexed or RPI rent: rent increases in line with an index such as Retail Prices Index.
Interim rent: In a lease renewal under Landlord & Tenant Act 1954, there is often a ‘gap’ between the end of the old lease term and a new rent being agreed. The rent in this period is calculated by reference to Section 24.
Side-by-side or geared rent: Sometimes a head landlord will let land to an intermediate landlord which develops and underlets. Head landlord gets a base rent and a share of rent from the underleases. This arrangement is no longer attractive due to stamp duty land tax (SDLT) and land transaction tax (LTT).
Stepped increases: rent increases by reference to a mathematical formula. Watch out for ‘doubling clauses’ and the like.
Turnover rent : Calculated by reference to the tenant’s turnover, profit or production at the premises, often as a percentage.