How to do a rent review – Part 2

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1.0  Introduction 

1.1 –  At rent review, the starting point obviously is to read the lease. I say ‘obviously’ because it never ceases to amaze me just how many landlords and tenants I come across having a go at rent review without bothering to read the lease. It’s as if they think that by diving straight in, the rent could be agreed regardless. After all, how hard can it be? The landlord proposes, the tenant counter-proposes, the difference between the respective offers is gradually narrowed by to-ing and fro-ing until a mutually acceptable figure is reached. Whether bartering reflects the provisions of the lease is anyone’s guess!

1.2 –  When bartering isn’t working – to barter the participants have to want to play the same game, or that one or both parties are sufficiently au fait to know that the lease plays an important part, or where surveyors are representing either one or both of the parties, or where a third party is required to fix the rent, the technicalities become the dominant factor.

1.3 –  Negotiation at rent review involves psychology- psychology at rent review is about how to influence decision-making so as to get what you want – but negotiation in isolation (that is, without regard for the technicalities of the lease) is unlikely to succeed when involving the technical stuff is also required.

2.0  Reading a Lease

2.1 –  When reading a lease, it is important to remember that the literal meaning of the words and phrases can differ from how those words and phrases would be interpreted. As I have explained elsewhere on LandlordZone, words are neutral but can attract connotations which can be positive or negative, depending upon the point of view. Interpretation is either from case-law or in the absence of any case-law an objective point of view. A subjective viewpoint might apply if that is what the law would also think. Subjective in isolation could be overly-emotive. But the fact that a different interpretation might apply, also trying to work out what is meant by some word or phrase, is quite possibly what leads to many landlords and tenants to cut to the chase and focus on the rent in isolation.

2.2 –  No matter how convincing an adviser might sound, either they know how to read a lease or they don’t. Often they don’t so if you are none the wiser then what they do know might not be enough. When you know how to read a lease, what you’re looking for is to spot any words or phrases that could materially affect the rent review, which means not only knowing what to look for but also where to find it. To expect everything and anything to do with the rent review to be in the review clause itself is unrealistic. The review clause is likely to mention provisions of the lease and generally those provisions comprise all the words and phrases in the lease as a whole including any related documents.

3.0  Drafting a Lease

3.1 –  Old ways have progressed to a more streamlined less haphazard approach to drafting leases. In the process, what might have comprised only a few pages is nowadays often a lengthy document. One reason for an increase in the number of pages is the inclusion of more detail. The theory is that the more expression and explanation a lease contains, the less likely the need for interpretation. In practice, whether that aim is achieved depends on the complexity of the terms and conditions, and mostly how much is at stake.

3.2 –  In a well-drafted lease, (including any related documents), the opening paragraph(s) will state the name and address of the parties and what they are to be known as in the lease: for example, ABC (“Landlord”) and XYZ (“Tenant”). There will be a ‘definition’ and/or ‘interpretation’ section in which meanings of the terminology (words and phrases) will be defined. The meanings are not necessarily literal but meanings within the context of the particular lease. Whether the ‘definition’ section is comprehensive depends upon the eagle-eyed skill of the lawyers, the parties themselves, and any other advisers (surveyors in particular) involved in the drafting and approval of the documentation. When drafting leases most lawyers use precedents, fair enough by reason of minimising costs and time-saving, except that there is no one size fits all. Problems can arise when precedents are followed slavishly without regard for the nature of the premises and the consequences in practice.

3.3 –  Usually the ‘definition’ section will incorporate matters specific to the actual landlord and actual tenant. The remainder of the lease (including any related documents) devoted to matters of a more general nature where the bulk of the wording and phrasing is interspersed with the words and phrases from the definition section. The generalities include (but not limited to) the operational covenants and conditions. In addition, typically, leases contain schedules for particular aspects, for example: rights reserved, rights excepted, service charge, format for Authorised Guarantee Agreement, and so on.

3.4 –  At or towards the end of the lease are the signature page(s). On engrossment, a lease is drawn up in two identical parts: the lease, which is signed by the landlord, and the counter-part, which is signed by the tenant. On completion, the parts are exchanged so that each party has a copy of the lease signed by the other. The two-parts arrangement is to avoid dispute and mostly that aim is achieved. Occasionally, some content of one part will differ and that can happen because when the draft document is finalised it is common for spaces to be left blank pending completion and one or other of the party’s lawyers have forgotten to fill in the missing information on completion. It can also happen when the parties agreed to alter something in manuscript (handwriting) but one party has not made the alteration. Amongst the mistakes that I have encountered are the duration of the contractual term, review dates, and wording of the user clause.

3.5 –  After completion, whether a mistake can be rectified depends upon whether it was a genuine mistake by the original parties. In the event of dispute, the court will want to investigate what was envisaged by both parties. Normally, a mistake cannot be rectified where the identity of one or both of the original parties to the lease has changed after grant of the lease.

4.0  Dates in Leases

4.1 –  The lease date is simply the date of the document and it is entered, usually in manuscript (handwriting), as distinct from typewritten, onto both parts of the lease on completion of the lease. Unlike buying and selling where contracts are normally exchanged before completion, a period of time between exchange and completion, leasing transactions do not exchange contracts but go straight to completion. The only time a lease would not complete straightaway is when an agreement for lease is entered into. An agreement for lease is when the parties want to be legally bound to a transaction that is subject to condition(s) that will take time to satisfy; for example: a pre-let before the property is built, or a letting subject to obtaining planning permission. The agreement for lease will incorporate the agreed form of lease and once the condition(s) is/are satisfied the lease itself would be completed, the agreement for lease then becoming redundant.

4.2 –  The term commencement date is the date of commencement of the contractual term. The duration of the contractual term would be defined in the lease, so too what is to happen during any statutory continuation, if applicable. (A lease (business tenancy) is inside Landlord and Tenant Act 1954 unless otherwise stated in the lease, also the statutory procedure for contracting-out complied with. A lease will not be outside LTA54 otherwise.) Sometimes the term commencement date will be the same as the lease date, but it can pre-date the lease (document) date: commonly on lease renewal where the renewal contractual term runs from the previous lease expiry or notice end date.

4.3 –  Where the rent review date(s) are not stated in the lease, whether the review date(s) are to be computed from the lease date or the term commencement date depends upon what the lease says.  The review date is the valuation date unless the lease specifies a different date. A different date does not have to be specified in the lease: it could be a date that would be known only after the review procedure is started. Where the review is initiated by notice, it is not unusual for the date of the notice to be the valuation date, as distinct from the review date. Whether the revised rent payable date is necessarily the same as the review date also depends upon what the lease says.

4.4 –  There is no standard lease. Some landlords, some tenants, many lawyers, have their own standard format, and the Law Society has a ‘template’ lease, but regardless of the format, the actual terms and conditions between each landlord and tenant and for the actual premises is a matter of agreement between those particular parties. To save time and costs, lawyers generally use and follow precedents, often slavishly, and frequently with not enough thought whether the practical consequences would suit the rental of the premises, Rent, as I have said, is a product of the lease: one cannot state categorically “this is the rent for the premies” without also stating and defining the terms and conditions of the existing lease or that is to be granted.

4.5 –  Lease content and style is fashionable. Over the years, the trend has been away from a dictatorial rent review approach into a looser procedure. Arguably, the chief reason for the change in attitude stems from 1977 when whether time is of essence for a rent review was considered by the House of Lords, in United Scientific Holdings v Burnley Borough Council.

5.0  A Series of Steps

5.1 –  Rent review procedure may be described as a series of steps, of which some are not necessarily sequential. Whether chronologically or out of order depends upon the parties’ strategy for their respective agenda.

5.2 –  Unless the review date is specified in the lease, the first step is to compute the review date according to the lease. To ascertain the correct date, the starting point is not to assume the lease date or term commencement date, but to read the review clause. Somewhere in the review clause the parameters will usually be stated: for example: the anniversary of the fifth year of the term. Thereafter, read the lease for the definition of ‘term’.

5.3 –  The next step is to initiate or trigger the review. This step includes any time limits. Time limits can be vital or critical in review procedure, because failure to comply can mean the landlord losing the right to review, or the tenant losing the right to object.

5.4 –  Depending upon what lease says, triggering the review can be by notice. Even where no (formal) notice is required, some communication that the review is to be operated will be needed. In my opinion, review communication should be in writing. To communicate triggering a review orally/verbally, possibly with a rent proposal, can lead to misunderstanding and in the event of dispute make it difficult if not impossible to prove what was said precisely. Despite connotations that can attach to words, at least with a communication in writing there is less room for doubt; the communication can also be read at leisure. Where a notice is required, to do so casually can be a mistake. Notices are usually in writing. The wording and phrasing of the notice, whether the notice can be headed ‘without prejudice’ and/or ‘subject to contract’, the mode/method of service, the address for service of the notice, when the notice should be served, whether any counter-notice is required, whether the notice has to specify the rent or contain a proposal, can if the procedure in the lease is not complied with cause problems for either landlord or tenant.

5.5 –  That second step (notice or not) can be a hurdle for people for whom British English is not their first or native language. For the inexperienced and uninitiated, the language of leases can be intimidating. As well as the legalese, reading the ‘small print’ in lengthy documents is not something that pleasures most people. But unless the ‘how to set the review in motion’ step is followed to the letter or the person starting the review is knowledgeable enough to know that any time-limits in the lease can be safely ignored, there is the risk that indifference to the requirements of the lease could result in a lost opportunity.

5.6 –  The third step is to how to determine the rental value. Assuming the review is to market rent – as distinct from some formulaic rent to be calculated arithmetically, in which case the calculation can be communicated for agreement – the basis for market rent is determined by what is known as the ‘hypothetical lease’.

5.7 –  Where a rent review is to market rent, the review clause will incorporate the hypothetical lease.  Hypothetical is a supposition. Suppose the premises were to be let in the (open) market – ‘open’ is superfluous (and stems from a bygone era when markets were not necessarily open to everyone) – what rent would the premises fetch? But as I have said elsewhere on LandlordZone it is not simply a matter of rent in isolation, but what rent on the terms and conditions of the lease that would be granted.

5.8 –  The hypothetical lease contains various matters to be assumed and disregarded and what those matters are will be stated in the review clause. Often the hypothetical lease will replicate the principal terms and conditions of actual lease but not always and it doesn’t have to. In fact, the wording in the hypothetical lease is often used to overcome any limitations on the market rent that the (actual) lease might be imposing. For example, the user clause in the (actual) lease might be restrictive, but in the hypothetical lease unrestricted. The hypothetical lease will also refer to the duration of the term, whether the original term or the unexpired residue or the unexpired residue subject to a specified minimum period. The general rule is that the term is calculated from the review date unless stated otherwise. (In part 3, I shall discuss the hypothetical lease is more detail.)

5.9 –  Although a rent review can be stopped in its tracks at the notice stage by reason of invalid notice and/or time-limit, it is at this step for determining the rental value that negotiations can become complex and protracted. At rent review, the rent is not subjective, not what the actual landlord might want or the actual tenant could afford, but objective as between a hypothetical willing landlord and hypothetical willing tenant, whose meanings are enshrined in case law. Rent is a matter of informed valuation opinion and, depending upon the nature of the premises, there may be different valuation methodologies, of which the most commonly used is probably ‘comparable evidence’. What constitutes ‘comparable’ is more than just comparison with pro-rata rents of other premises, it goes beyond that narrow way of thinking into the wider realms of leases of other premises. Moreover, valuation is both an art and a science. Opinion doesn’t have to be logical. The body of case law concerning the interpretation of matters involving the hypothetical lease is extensive. Explaining the intricacies can be time-consuming, all the more so when an inexperienced landlord or tenant’s expectations for the rental value differ from experienced thinking and informed interpretation.

5.10 –  Most rent reviews are settled by agreement but, where agreement cannot be reached, leases normally contain a procedure for resolving disputes, generally known as ‘referral’ to a third party. The third party is required to be impartial. It is at this step that the wider consequences for the parties, which up until now have taken a back seat, enter the fray.

5.11 –  The third step (determining the rental value) and this referral step do not have to be taken sequentially. Often, the referral step is taken whilst the third step is still continuing. And sometimes, the referral step is taken after the trigger notice step. Whether chronologically or out of order depends upon the parties’ strategy for their respective agenda.

5.12 –  The principal wider consequence is whether one or both of the parties is to be responsible, both initially and ultimately, for the cost of the dispute procedure. Costs consist of the cost (if any) of applying for a third party, the third party’s own costs, and the respective parties’ own costs.  Where referral is to arbitration, never mind what the lease might say about costs, the Arbitration Act 1996 overrides so the arbitrator has overriding jurisdiction. Where referral is to a surveyor acting as an expert, known as an Independent Expert, the parties’ responsibility for costs will depend upon what the actual lease says. Where the lease is silent on the Independent Expert’s costs, the party making the referral would normally be responsible for the appointed Independent Expert’s costs unless otherwise agreed with the other party. Fortunately for landlords and tenants the number of draftspersons that think that an Independent Expert has the same jurisdiction on costs as does an arbitrator is diminishing!

5.13 –  Although many landlords and tenants suggest that ‘reasonable people’ should surely be able to agree a rent review without involving a third party, let alone needing to instruct surveyors to represent the respective parties’ interests. That way of thinking on the face of it makes sense, especially between experienced landlords and unrepresented small tenants, the latter for whom the cost of a surveyor on their side might be promoted by the landlord as a waste of money for the tenant, the tenant thinking the same but for different reasons, the reality of rent review otherwise is different.

5.14 –  There is no such thing as a rental ‘norm’. Different landlords have their own investment policies. Different tenants have their own business plans. In the more confrontational locations, such as city centres, larger towns, and suburbs, and where the landlord is keen to improve rental yield (return on capital) the rent review relationship between landlord and tenant is diametrically-opposed, the landlord wants more, the tenant less. Often, the rent review clause is worded as upward-only: the greater of the market rent and the rent passing. As I have explained elsewhere in LandlordZone, an upward-only review doesn’t mean the rent necessarily has to go up; simply that the rent payable after the market rent is agreed or ascertained would not be less than the rent payable before the review. While there is bound to be disagreement on how much of an increase – ‘review’ doesn’t have to mean “increase” but amongst landlords generally implied – landlords are, unless external events are such, rarely content with no increase, at least not for a long period of time.

5.15 –  Amongst many landlords is an inclination to commission a preliminary report by a surveyor on the market rent. As an approach to review, frankly I think having nothing to show for it is short-sighted and most surveyors regard such instructions as a lucrative money-spinner. With fees charged by surveyors for rent review competitive, often the cost of the report can exceed what a surveyor would charge to handle the review. What the landlord gets is a one-sided opinion of the market rent which might not encompass all the evidence that could emerge if the review were to be initiated. Nothing ventured, nothing gained!

5.16 –  Rent review negotiating psychology depends upon with whom you’re dealing and up against. There are no hard and fast rules. Many surveyors when acting for tenants believe that the landlord should have to justify an increase, but that is a nonsense and unsupported by case law. A rent review is for the benefit of both parties, albeit tenants rarely see it like that. Although involving the dispute procedure might be thought best avoided at all costs, referral is commonly used as a negotiating ploy. Initiating referral does not mean having to go the whole hog. The rent can normally be settled by agreement at any stage of the proceedings before a third party has determined the rent; the costs shared by agreement. Referral as a step to be taken in parallel as distinct from a last resort when all else fails is often capable of achieving better results.

6.0  Recording the Agreement

6.1 –  The final step is recording the agreement. Generally in the form of a Memorandum signed by both parties and sometimes any guarantor(s), rather than endorsement of the lease and counter-part. Where a rent is fixed on referral, the third party’s award or determination serves as evidence of the revised rent but it is generally administratively simpler to complete a Memorandum . A Memorandum also avoids the need to disclose how the review has been arrived at.

6.2 –  My standard draft form of Memorandum has met with the approval of countless lawyers. Not pre-printed, I draft each Memo from scratch, in free-form layout.

6.2.1 –  A plain sheet of paper headed Memorandum of Rent Review. Whether or not the lease uses numbers in parentheses I do, to differentiate between the parties. For example; Pursuant to the Lease dated x (dated is optional, usually I put Pursuant to the Lease x where x is the date in full) between (1) A (A = name of first landlord) whose interest is vested in B (B = name of  current landlord), (“Landlord” or whatever terminology is used in the lease  and (2) C (C=name of first tenant) whose interest is vested in D (D= name of current tenant) (“Tenant”) – ditto – and (3) E (guarantor or surety if appropriate), the Landlord and Tenant (hereby – optional) agree that the rent from and including (date in full) is £ per annum (exclusive of VAT is appropriate). Signed …. (shorter name of landlord above dotted line, with space for signatory to enter name in block capitals and position if a corporate entity; ditto for the tenant.  The date of the Memo is left blank for the landlord to fill in, unless the Memo is to recorded a third party agreement itself dated.

6.3 –  You might think how to word a Memorandum would be obvious, but when you’ve read as many Memos as I have one wonders what the draftsperson is afraid of!  Fear I guess is that because a Memorandum is legally-binding, wording has to be convoluted and/or stray from the lease terminology. For example, where the landlord in the lease is known as ‘Lessor’ and the tenant as ‘Lessee’ there might not be any difference in practice but that doesn’t mean the Memorandum should refer to the parties as ‘Landlord’ and ‘Tenant’.

6.4 –  How a Memorandum is worded can affect the capital value of the landlord’s interest. Generally, tenants are more interested in the rent payable after the review is agreed or ascertained (by a third party) so if the rent payable after the review is agreed were the same as the rent previously passing (payable beforehand) – what is known as ‘nil increase’ – then the chances of the tenant being interested in agreeing the market rent itself are none. But  nil increase does not mean the passing rent is too high – known as ‘premises overrented’ –  it can also mean the passing rent is the same as the market rent or near enough as to not be worthwhile pursuing any increase.  By stating in the Memorandum that the market rent is £x or disguising the fact by referring to the Lease (as one would expect in any event), the rent review is agreed as the market rent pursuant to the lease.

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