In commercial leasing, rent review clauses can make or break a good outcome for both a tenant and landlord. The rent review clause is a provision which provides the landlord with an opportunity to review the amount of rent payable by the tenant during the term of the lease. This is important as it allows the landlord to alter the rent to reflect the changing market rates and inflation.
Rent reviews are almost always "upwards-only" meaning the rent cannot decrease upon review. Rent reviews can take place at whatever intervals are agreed by the parties to the lease however, common intervals could be every 3 or 5 years. This means that commercial leases with a duration over 5 years will very likely contain a rent review clause.
Types of Rent Review Clauses
There are three main types of rent review clauses:
- Open Market Rent Review Clauses
The first and most common type of rent review clause is open market rent review. This is where the rent is altered to reflect that which a similar premises with a lease with the same terms and conditions would fetch. This type of rent review clause is commonly used as any increase in rent reflects a fair market value for both the landlord and tenant.
- Index-Linked Rent Review Clauses
The second type of rent review clause is an index-linked clause. These clauses are linked to an index, where the rent increase mirrors the proportionate rise of the index. Commonly, these are linked to the consumer price index (CPI) or the retail price index (RPI). Index-linked rent review clauses can be used where the premises are unique and not easily compared on the open market.
- Stepped/Fixed Rent Review Clauses
The last type of common rent
review clause is the fixed rent review clause. This is where the landlord and
the tenant agree on a fixed percentage increase of the rent for each rent
review interval. This clause is a safe option for landlords, ensuring that
should the market fall, there will be a fixed rise in the rent nonetheless. It
also leaves the tenant with greater clarity on their budgeting as they have
certainty on their rent figures for the entirety of the lease.
How Does This Impact Tenants?
For tenants, fixed rent review clauses will pose a problem if the tenant is locked into a long lease and the market rate falls. In this instance, the tenant may be stuck paying a higher rate than they may pay with competitors. However, tenants may also benefit should the market sharply rise, and their rent has a fixed, lower increase. Unfortunately, for tenants, landlords will strongly resist a rent review clause that allows for rent to decrease as it opens the landlord to loss of income if the market should fall. Tenants must also be weary of index-linked rent review clauses which, during recent periods of high inflation, have driven up rent substantially. In such cases, tenants can seek a cap on the value of the increase in rent when agreeing the terms of the lease to ensure the rent does not become unaffordable.
The rent review clause must be carefully considered by the tenant to ensure increases in rent will not prove fatal to their business.
How Does This Impact Landlords?
For landlords, ensuring the correct rent review clause is key so that you do not miss out on potential income from rising markets. This is especially important in longer-term leases. The choice of review really depends on what the landlord needs. Sometimes it will be better to go with a fixed review clause to ensure that a certain amount of rent is received across the term of the lease. Sometimes, landlords are more suited to the index-linked clause if they have a property which is hard to value on the open market. What is important is getting a clause that is tailored to the landlord's requirements.
The Land and Buildings Transaction Tax (LBTT) is a tax applicable to commercial leases in Scotland. If the lease is notifiable, LBTT is payable by the tenant at the outset of the lease however, a further LBTT return must be submitted by the tenant at every third anniversary of the effective date for the duration of the lease. This means that following a rent increase after a rent review, there may be more LBTT to be paid on the lease by the tenant on the subsequent three-yearly review.
Navigating rent reviews in commercial leasing can be challenging for both landlords and tenants. It is essential to understand your needs and negotiate terms that safeguard your interests, as the implications for your financial stability and business growth can be significant. If you are preparing for a rent review or dealing with the complexities of commercial leasing, our dedicated Commercial Property team is here to assist you. We will help you explore your options and develop strategies that align with your goals, simplifying your decision-making process. Contact us at 0141 221 1919 for a personalised consultation, and we will take the time to understand your unique situation, address any concerns, and provide tailored solutions that make a real difference.
