Real Estate Law UK Essay

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UBLMCG-15-M09024425Real Estate Law:Do UK Rent Reviews represent an advantage for Landlords?AbstractRent reviews have developed to become an essential provision in many leaseagreements. Designed to protect landlords’ interests against inflation, rentreviews are now a fiercely contested subject within property law. Upward onlyrent reviews are a particularly litigious area, and are standard in most UK rentreview clauses but have been met with strong opposition from some tenantswho feel these offer unfair advantage to landlords. This situation has fuelledlobbying for legislation to restrict their use in UK leases and the government todevelop codes of practice intended to raise awareness of alternative leaseoptions. This discursive essay sets out to provide a brief overview of thedevelopment of rent reviews in the UK and the relevant case law. It will focuson three key areas, namely the procedures for serving rent review notices, thereview valuation process and the upward only basis of most UK rent reviews.These will be evaluated individually to assess whether they favour thelandlord and whether UK rent reviews as a whole represent an advantage forlandlords. On first inspection UK rent reviews appear preferential to theLandlord. However on further analysis they offer equal opportunity to bothparties, particularly when you consider both parties are ultimately free tonegotiate the terms of the lease and the vast majority of cases the courts willuphold this.Keywords:rent, review, landlord, tenant, advantageHistorically the law of England and Wales has largely left parties free tonegotiate the initial form of a commercial lease (Wilson & Long, 2011, p2).The Landlord and Tenant Act 1954 which bestows a statutory right of renewalon commercial tenants has been the key intervention although the Act doesnot provide any regulation in terms of rent.As the concept of land ownership has developed through history so too havethe leases that facilitate it. Generally older leases did not consider the effect ofinflation and were often agreed at rents fixed for very long durations asLandlords sought security of income. Due to the increasing level of inflation inBritain lease structures developed in the 1970s to satisfy the requirements ofpension funds and insurance companies investing in property (Garner & Frith,2013, p71-72). The ‘Institutional lease’ as it is referred to was typically held ona full FRI basis for a term of 25 years without a break option and with 5 yearlyupward only rent reviews.Rent review clauses have always been a highly contentious issue particularlywith regards to the upwards only basis of most commercial UK leases. The1
UBLMCG-15-M09024425significant variety of rent review provisions has prompted litigation over theinterpretation of rent review clauses despite an extensive volume of existingcase law on the subject (Gatty, 2005). The recent structural shift towardsshorter leases has seen a decrease in the occurrence of rent reviews(BPF/IPD, 2007, p3). However, Loveday et al. report there is no evidence ofan accompanying decrease in the number of disputes (2008, p11). Disputesprincipally centre on the pattern of the review, the review valuation processand the serving of notices.A Rent review clause is a clause inserted into lease agreements to “allow theperiodical adjustment of commercial rents to the market level current at thedate of review” (RICS, 2014). In the UK rent review clauses vary considerablyand although no specific wording is required they tend to place certainobligations on the parties concerned, such as requiring a rent review at statedintervals. The new rent payable after the review is stipulated as that which thelandlord might reasonably expect to obtain on the open market if he were tore-let the premises on the review date. They are typically not geared to anindex and specify that the rent may be reviewed upwards only (Wilson &Long, 2014, p2).A well-drafted rent review clause will clearly specify the dates on which therent shall be reviewed, the machinery for the review, the basis of the revisedrental valuation, the process to trigger the review as well as the resolutionprocedure if the landlord and tenant fail to negotiate independently (RICS,2014). Although the basic form for the contract is relatively simple, differencesof interpretation due to inconsistent drafting have resulted in a sizable body oflandlord and tenant case law (Baum & Crosby, 1995, 112).The purpose of a rent review is to give the landlord protection against inflationwhen property values increase by raising the rent in line with market rentalfigures (Card et al., 2003). Most rent reviews in UK leases are on an upwardsonly basis that also protects the landlord against falls in property prices byretaining the previous rental value. Upward only rent reviews require that if theopen market rental figure is in excess of the passing rent at the time of thereview, this will become the new rent payable for the following period(Loveday et al., 2008, p63).Machinery that allows the landlord to trigger therent review exclusively may have the same effect as an upward only rentreview, as a suitably informed landlord will not trigger the review if the marketrent is less than the passing rent.The case ofHemingway Realty v Clothworkers Guild[2005] EWHC 299concerned a tenant contending the right to review the rent with the landlordrefusing to review the rent as the market rent was less than the rent payable.Royal Insurance Property Services v Cliffway[1996]also involved a tenantseeking to initiate a rent review, this time on the basis that a memorandumpostdating the lease provides for upward and downward rent reviews. Thejudgment of Rattee J in dismissing the case reinforced the importance of thewording of leases. The majority of UK leases have rent review clausesexercisable by the landlord only, existing case law seems to furtherstrengthen this position to the detriment of the tenant.2
UBLMCG-15-M09024425Property prices plummeted in the 1990s following a boom period in the1980s. The outcome was a situation where many commercial tenants werepaying rents far higher than the market value. This led the Government at thetime to consider regulation restricting upward only rent reviews. The questionis whether the Parliament considered banning upwards only rent reviews wasbecause they are innately advantageous to landlords or whether it was areaction to a culture of tenant naivety in relation to lease terms, a situationexacerbated by the economic backdrop?While the Government felt it would be inappropriate to legislate againstupward only rent reviews the resulting consultation led to the development ofthe 1995 Code of Practice. The purpose of which was to ensure tenants werebetter informed about their rights and obligations, and to promotetransparency in lease negotiations (Wilson & Long, 2011, p2). The impact of1995 code was limited although some of the changes, such as shorter leaseterms, increased flexibility and an increase in repairing obligations on thelandlord, had materialised, these were not attributed to the code. Upwards-only rent reviews remained almost universal (Wilson & Long, 2011, p3). Thelack of interest in offering alternatives despite government guidelines to do sosuggests that landlords benefit disproportionately from upwards only rentreviews. In 2002 the government, unsatisfied by the reaction to 1995 codeagain considered legislation and once again opted to introduce a voluntarycode of practice. The 2002 code of practice had more impact than itspredecessor in that landlords began to offer alternatives however researchindicated no evidence of substantial change and upwards-only rent reviewsremained “virtually universal” (Reading University, 2004). This underminesthe argument that UK rent reviews are advantageous to landlords as tenantsare clearly more than willing to engage in them. This is because upward onlyrent reviews offer financial benefits to tenants (Loveday et al., 2008, p63). Thevalue of a lease containing an upwards only rent review provision willgenerally reflect the tenants loss of protection in a falling market therefore theinitial rent on a lease containing a upwards only rent review is less than anotherwise identical lease (French et al., 1997, p448). Nevertheless upwardsonly rent reviews remain unpopular among many in the industry.The fallout from the 2002 code of practice was the Government identifying theneed to target small businesses specifically in raising awareness of leaseterms and promoting transparency in negotiations. The result was the 2007code of practice for leasing business premises. Like the previous codes, the2007 code failed to achieve widespread integration. Despite manyorganisations responsible for corporate tenants and larger landlords fullyendorsing the code, the majority of transactions take place in completeignorance of the code’s existence (Wilson & Long, 2011, p13).The prevalence of upward only rent reviews remains an issue for thegovernment describing the broad-brush solution of upwards only rent reviewsas often “crippling factor in determining whether or not the business cansurvive” (Portas, 2011). This indicates the existence of upwards only rentreviews is disadvantageous to a tenant, however this view comes under3
UBLMCG-15-M09024425scrutiny when the findings of an earlier report by the British PropertyFoundation are considered. In their report “A BPF response to the ODPM’sconsultative paper on: Commercial Leases” they noted statistics from theInsolvency Service showed rent reviews ranked 11 out of 14 measures citedas a cause of business failure (BPF, 2004, p1) In addition to this they refutedthe claim which is regularly raised by detractors, that upwards only rentreviews are inflationary highlighting the underlying trend from 1975-2004 wasactually a fall of 0.5% (BPF, 2004, p1).The alternatives to upward only rent reviews must be compared in order toreach an informed decision on the best method. The machinery of a rentreview can take many forms, from upwards and downwards rent reviews,threshold rent reviews, turnover rents, stepped rents and indexation. Thelatter is widespread across continental Europe and considered by many to bea better option than upward only rent reviews. Indexation involves gearing therent to an index such as the Retail Prices Index, although in the case ofBritish Railways board v Mobil Oil Company ltd.[1992] the rent was geared toan index of the rents payable for other properties. Indexation commonlyincorporates rent reviews more frequently than the typical 5 year pattern, afeature emphasised by proponents as an advantage over existing upwards-only rent review patterns, as this ensures tenants are more likely to pay a rentin keeping with the market rental figure (Loveday et al., 2008, p65). However,the British Property Foundation champion the use of upward only rent reviewsas a strength of the UK market. The protection they offer landlords againstmarket volatility allows access to cheaper capital; this then benefits the tenantby being reflected in a cheaper initial rent and also encourages furtherlandlord investment (BPF, 2004, p1). Ultimately, the argument that upwardsonly rent reviews are advantageous to landlords is flawed. Upward only rentreviews are reflected in the initial rent and as such they offer financialadvantages to both the landlord and tenant.Aside from the basis of the rent review, the review valuation itself is heavilycontested in case law, particularly with regards to the gathering of legalevidence. In the UK the standard nature of a rent review is that at specifiedintervals where a current open market rental value for the premises exceedsthe passing rent, the new figure is substituted for the following period (Card etal., 2003, p540). With regards to valuing rent reviews it should noted that theintention of the parties is primarily ascertained through analysis of the wordingin the lease. This point is reinforced in the judgment inCadogan v Escada[2006]. The case centred on the landlord’s argument that the wording of thelease might not be ‘commercially realistic’. Ruling in favour of the tenant, thejudge recognised his view, although dismissed the case, as ‘that does notmean however that the court can rewrite the words that the parties have usedin order to make the contract conform to business common-sense’. However,In the event of ambiguous wording in the lease, the courts may adopt themost commercially realistic meaning (Loveday et al., 2008, p20).Aside from the usual rules applicable to all contracts, the courts apply the ruleof ‘presumption of reality’ to the construction of rent review clauses. The aimof which is to stress the commercial purpose of the review procedure rather4
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