Jack Lightburn looks at the government’s proposal to ban upwards only rent reviews and the likely impact of these changes on the commercial real estate letting market.

The long-standing practice of upwards only rent reviews in the UK commercial property letting market may soon end following the publication of the English Devolution and Community Empowerment Bill (the Bill) on 10 July. In this article, we discuss the background of upwards only rent reviews, the proposed changes and their potential impact on the UK commercial property sector.

Background

Upwards only rent review provisions have been market standard in commercial property leases for decades, affording commercial landlords the comfort that rents will never drop following a review while placing the full risk of economic downturns on tenants, who may end up overpaying in declining markets.

When announcing the Bill, the government commented that upward only rent reviews “pit landlords against businesses and can make rents unaffordable and cause shops to shut”. The Bill "will help end the blight of vacant high streets and the unacceptable antisocial behaviour that comes with them". 

The government's view is that previous attempts to steer the market towards upwards/downwards reviews voluntarily have failed and statutory intervention is needed. For example, early iterations of the RICS lease code encouraged landlords to offer priced alternatives to upwards only reviews (for example, an upwards/downwards review in exchange for a slightly higher initial rent), but these types of arrangements were not widely adopted. Upwards only reviews have become so prevalent that the latest edition of the code (RICS Code for leasing business premises, 1st edition February 2020) no longer even recommends that parties consider such priced alternatives. 

This latest move follows the bringing into force of new regulations last year to implement high street rental auctions, allowing councils to auction off high street premises under short term commercial leases. These changes are part of a broad strategy aimed at tackling the issue of empty high streets. 

It is safe to say plans to eliminate upwards only rent reviews have come as a huge shock to the industry, particularly as they did not form part of the Labour Government's election manifesto and there has been no prior consultation.  Lobbying from institutional landlords, representative bodies and other major stakeholders is likely to be forthcoming.

Main proposals 

The relevant provisions of the Bill are set out at Clause 71 and Schedule 31 and if implemented would amend the Landlord and Tenant Act 1954 (the 1954 Act).  The key points to note are:

• The ban would apply to business tenancies within the scope of Part II of the 1954 Act (not just those with security of tenure). This would cover the vast majority of commercial leases.
• It would not be retrospective, i.e. it would apply to new leases only (including renewals) save for certain exceptions, such as leases granted pursuant to a contract entered into before the changes come into force.
• It would generally apply to any upwards only rent review mechanism where the amount of the potentially higher new rent following review is uncertain when the lease is granted. This would capture both open market and index linked reviews, but stepped rent increases of pre-agreed amounts would be allowed.
• Any triggers in rent review provisions which are drafted so that they can only be taken by the landlord would be impliedly amended to allow the tenant to take the same action.
• There are strong anti-avoidance provisions, including a prohibition on any put option requiring tenants to take a lease at a rent that is determined by a method contrary to the intentions of the Bill. 

Potential impact

It is very early days, but some of the potential impacts on the commercial property industry are:

• Tenants might start asking for upwards/downwards reviews now, in anticipation of these changes coming into force. This may have an impact on other commercial terms and the negotiations generally.
• The end of rent review provisions which include a collar (a minimum increase). This may lead to landlords being less inclined to agree to a cap, given that caps and collars usually go hand in hand.
• An acceleration of the trend towards shorter lease terms, as some landlords may be unwilling to agree to any leases which contain a rent review. At the end of the term, the parties could then negotiate the new rent on an open market basis if/when the lease is renewed.
• Fewer landlords willing to grant protected leases (i.e. with security of tenure), as they would be potentially susceptible to longer lease terms and upwards / downwards reviews imposed on them on statutory renewal.
• Institutional landlords exiting from the market, as they will no longer have the certainly of a minimum level rent for the duration of lease terms. This may also have an impact on their financing arrangements, the terms of which are often underwritten by the long term security of a steady minimum level of rental income.
• Higher initial rents, if landlords price in the risk of a downwards review during the term. This would be contrary to the government’s stated aims and rationale behind the changes.
• The fact that (in theory at least) rents will follow the market more closely would hopefully lead to fewer disputes of the kind experienced during the COVID-19 pandemic. Downward reviews may enable more tenants to survive in economic downturns.
• The risk of downward rent reviews may persuade more landlords to proactively improve their properties, as they will no longer be able to rely on upwards only reviews in stagnant or falling rental markets.
• A move towards more leases with fixed stepped rent increases. Landlords may set the stepped increases at optimistic levels to mitigate the risk of the premises becoming under-rented in a booming market. This could result in tenants being worse off in a falling market than they would have been with an upwards only open market review. 

It is important to note that, at present, these are just proposals and subject to change as the Bill progresses through Parliament. The second reading of the Bill is likely to happen after MPs return following the summer recess. Given the controversial nature and wide-reaching impact of the proposed changes, the merits are likely to be hotly contested when the Bill reaches the debating stage. Watch this space. 

If you have any questions on the above or require advice in this area, please contact our real estate team.