In a move that has made headlines across the commercial property landscape, the government has proposed a ban on upwards-only rent review clauses in new commercial leases. This unexpected provision, tucked away in the English Devolution and Community Empowerment Bill, marks a significant shift in commercial lease dynamics, with the potential to impact the value of commercial lease portfolios and reshape the rights of landlords and tenants alike.
Background
Upwards-only rent reviews allow rent to be revised at regular intervals without ever decreasing, even if market rents fall. Such provisions have long been standard within commercial leases, ensuring rental income remains stable regardless of economic downturns. The presence of an upwards-only rent review is also typically a requirement of institutional investors.
Traditional retail models have been experiencing various pressures in recent years, and the government has argued that upwards-only rent reviews artificially inflate rents, pricing out small businesses from high streets and town centres and contributing to inefficiency within the market. The reform is framed as part of a wider government effort to make commercial leasing fairer for tenants and to stimulate long-term economic growth.
Legislative Proposal
The proposal applies to all new commercial leases and renewals governed by Part 2 of the Landlord and Tenant Act 1954, with the effect that the revised rent under a rent review will be unenforceable if it is higher than the reference amount under the lease (the reference amount being the rent calculated according to an open market, index-linked, or turnover-based rent review). The result is that the revised rent on a rent review will simply be the rent revised in line with the method of rent review – rather than the higher of the newly calculated rent and the existing rent (meaning rents can go downwards as well as upwards).
Other key features of the proposed new law include:-
- Provision for tenants to trigger rent reviews.
- Anti-avoidance measures to prevent landlords from circumventing the ban through side agreements.
- No circumvention: parties may not agree to override the ban even by mutual consent, unlike the contracting process for a protected tenancy under the 1954 Act.
The ban is not retrospective, so existing leases and agreements for lease will remain valid, provided they are entered into before the prohibition comes into effect.
Impact on commercial lettings
The government's proposals have been introduced without any prior warning or consultation, and are likely to face significant pushback from landlord groups and institutional investors. Though intended to help small or high street businesses, the measures are likely to capture a wide range of leases, particularly those with longer lease terms. The proposal has the potential to undermine property values, disrupt lending and investment strategies, and increase market volatility. As a result, the cost of financing commercial developments is likely to become more expensive. All these factors may lead to commercial property becoming less attractive to investors, causing an unintended impact on the wider economy.
Implications for Landlords
In light of the proposals, landlords should consider how to structure leases to strategically manage the resulting risk of losing rental income. If the measures become law, landlords may wish to consider the following measures:-
- fixed or stepped rent increases, which remain permissible within the proposed law.
- index-linked reviews, which allow rents to rise or fall with inflation.
- higher initial rents, offsetting the possibility of future rent reductions.
- shorter lease terms with fewer rent review intervals.
- turnover-based rents or hybrid models, which align rental income with the tenant's financial performance.
Implications for Tenants
The ban on upwards-only reviews will be a welcome proposal for many tenants, especially independent retailers and SMEs, as it would offer greater flexibility in lease negotiations and a safety net in the event of market downturns. The measure might even make tenancies in more exclusive locations more affordable over the long term. Tenants will also have the option of initiating a rent review.
Despite the benefits, tenants should remain mindful of the fact that landlords may incorporate other provisions in the lease which are unfavourable to the tenant in an attempt to offset the risk of losing rental income. Though it remains to be seen how landlords will respond, landlords may incorporate higher initial rents or fixed rent increases, essentially defeating the purpose of the new measures. It may also lead to landlords imposing stricter break clauses and more onerous service charges on tenants.
Looking forward
The bill is still in its early stages, and is not expected to become law for at least 6 to 12 months. Responses are expected from industry bodies, which have the potential to influence amendments to the bill. The proposals represent a significant shift in the structuring of commercial leases, introducing additional uncertainty into an already complex area. Whether the proposals pass in their current form or undergo revision, all stakeholders should stay alert to the implications and seek relevant professional advice.
For further information, or to discuss the issues raised within this case, please contact us to speak to a member of our Real Estate Team.
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