Now is a particularly relevant time to consider commercial lease rent review provisions due to:
- improving economic conditions resulting in increases in market rents;
- legal developments regarding upward only rent review clauses; and
- five years passing since the ban on upward only rent review clauses in new leases.
Rent review clauses and their operation are of equal interest and importance to landlords and tenants who are approaching rent reviews in existing leases and negotiating a new lease containing rent reviews.
A landlord and tenant set out the agreed terms for occupation of property in a lease. If the term is for more than a few years, the landlord will want to vary the rent payable, usually every five years. Previously, the landlord would insist on upward only reviews but these were banned in 2009. For any leases after the effective date, most reviews will be based on market conditions.
Save for the recent legislative ban on upward only rent reviews, rent reviews are not governed by statute and are entirely a matter of contract between the parties. Rent review clauses should be carefully negotiated as their provisions have a significant financial impact on both parties.
Here are seven things all existing and prospective landlords and tenants of commercial property need to know about rent reviews.
- When does the rent review arise?
- In leases of commercial property, usually every five years.
- How is the rent review activated?
- Some clauses provide that only a landlord may activate the rent review (to avoid a tenant trigger if rents have fallen). Most of those pre 28 February 2010 and some post 28 February 2010 will allow either party to activate the review.
- How is the new rent determined?
- Leases, or agreements for lease, before 28 February 2010 will, by and large, contain upward only reviews.
- Leases from 28 February 2010 are supposedly based on market levels but landlords are using various means to avoid a drop in rent – e.g. CPI (inflation) increase, setting maximum and minimum rents on review, stepped rents or turnover rents.
- What happens if agreement cannot be reached?
- That depends on the lease. The parties may have agreed for an expert or an arbitrator to decide, if not, a court application may be needed.
- What are the relevant factors in determining the new rent?
- Again, the answer depends on what the parties have agreed in the lease. Usually, the rent will be determined on the basis of various hypothetical assumptions and disregards.
- Landlords will seek an assumption of full compliance with all landlord and tenant covenants.
- Tenants will want a disregard of all tenant works and goodwill.
- The assumed permitted user under the lease is of crucial relevance.
- The assumed residue of the term of the hypothetical lease is also an important indicator for determination of the new rent.
- What is the interim position pending determination?
- The lease will often state that the rent payable prior to the rent review date continues to be payable pending the determination.
- The new rent is ordinarily stated to be backdated to the rent review date. Some leases add interest.
- If the rent is reduced, then the landlord must refund the overpayment.
- Is there any notification requirement?
- Tenants have a statutory obligation to provide details of any reviewed rent or variation to the rent review provisions of a lease to the Property Services Regulatory Authority. Failure to comply with this obligation is an offence liable on conviction to a substantial fine.
In summary, both existing and prospective commercial landlords and tenants should be alive to the detail of the provisions and practicalities of rent reviews.
When either approaching a rent review in an existing lease or negotiating a new lease containing a rent review, landlords and tenants should ensure that close scrutiny is paid to each and every clause of the rent review provisions to ensure that the contractual agreement reached by the parties is fully understood and correctly reflects the intentions of the parties as commercially negotiated.
Parties should take timely legal advice and arm themselves with knowledge of their respective legal positions according to rent review provisions to enable the parties to engage strategically with one another on rent review.