Summary
- An open-market assessment rent review is the most common type of commercial rent review in the UK, where the landlord assesses the rent by reference to what they could obtain on the open market for a hypothetical letting of the premises, with the review typically occurring every three to five years in leases of at least five years.
- Open-market rent reviews often include an upward-only clause (preventing rent from falling below its current level) and may include a cap and collar (setting maximum and minimum rent levels), with landlords required to disregard tenant improvements when calculating the hypothetical market rent.
- The rent review clause must clearly state whether time is of the essence, as this determines whether the landlord must conduct the review by a specific date or can exercise the right later in the lease term, which can significantly affect tenants who assume the right has been waived.
- This article is a guide to open-market assessment rent reviews for commercial landlords and tenants in the UK, explaining how this type of rent review works, the role of the hypothetical lease, and the key provisions to understand in a rent review clause.
- LegalVision is a commercial law firm that specialises in advising clients on commercial leasing and property matters.
Tips for Businesses
Review your rent review clause carefully before signing a commercial lease to understand the type of review, frequency, process, and whether time is of the essence, as these factors significantly affect your rights and obligations. Tenants should not assume a landlord has waived their right to review rent simply because the review date has passed, as the right may still be exercisable later in the lease term if time is not of the essence. Both landlords and tenants should seek legal advice when negotiating hypothetical lease terms within the rent review clause to ensure assumptions and disregards accurately reflect the actual lease circumstances.
Whether you are a commercial landlord or tenant, negotiating a fair rental amount is critical. If the commercial lease has a rent review clause, the rental payments may not remain the same throughout the lease term. Instead, the figure may undergo a rent review which could change how much a commercial tenant pays. There are different types of rent reviews you can use. This article will explain what an open-market assessment rent review is in the UK.
What is a Commercial Lease?
When business owners occupy commercial premises to conduct their business, they will likely have a commercial lease. This grants them sole occupancy rights for the premises for a permitted business purpose over the lease term. In return, the tenant must pay their landlord’s rent.
A commercial lease agreement details the rights and obligations of both the landlord and tenant. It will also describe other terms, typically including, for example:
- repair obligations;
- any break clause granting rights to end the lease term early; and
- assignment rules.
In addition, a commercial lease agreement will detail rental terms, such as the rent amount and any rent review clause.
Rent Review
A rent review clause will describe that a commercial landlord has a right to periodically assess the level of rent their tenant pays for the occupation of the commercial premises. This clause is usually present where a lease is for at least a five-year term and will usually occur around every three to five years.
A rent review clause will detail several points about the rent review, such as:
- the type of rent review the landlord uses;
- the time limit for applying the rent review;
- how often it occurs;
- the dates it should take place; and
- the process to take, including what a tenant should do if they disagree with the result of the rent review.
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What is an Open-Market Assessment?
An open-market assessment is where the rent assessment depends on what the landlord could get for the commercial premises should they let it to another tenant on the open market. The landlord compares the price the tenant pays to other similar types of properties in the same area and formulates a level of rent the tenant should pay. Therefore, this type of rent review is evidence-based. An open market assessment rent review is the most common type of rent review.
An open-market rent review often has an upward-only clause. This is to the landlord’s advantage as it ensures that regardless of the market value of similar properties, the rent will not decrease from the level it is currently at when the rent review takes place. Sometimes, however, an open market rent review will include a cap and a collar. These state a maximum and minimum level that the rent can reach.
When conducting an open-market review, landlords will inevitably make assumptions as they assess the rental amount for a hypothetical lease. The lease agreement should state the terms of the hypothetical lease, such as what the length of the term would be. A landlord would also need to disregard any changes the current tenant has made to the property, which can increase its value.
Key Aspects of Open-Market Rent Reviews
Below we discuss several critical points regarding open market rent reviews.
1. Common Rent Review Method
A key point to note about open market rent reviews is that they are the standard type of rent review method. The other rent review methods include:
- fixed increase by a specific percentage;
- a consumer price index rent review;
- turnover rent reviews; and
- percentage uplifts.
2. Hypothetical Lease
To carry out the rent review using an open market rent review method, a commercial landlord needs to refer to a hypothetical lease. The details of this should be in the rent review clause in the lease agreement. A commercial landlord and tenant both must take legal advice in regard to this. This is because it is essential that the hypothetical lease terms reflect the actual lease.
Hypothetical lease terms include assumptions and disregards, which the landlord takes. These must be accurate for the circumstances of the lease to ensure they establish an accurate open market level. For example, if there is an assumption that the landlord has carried out their lease obligations but does not, this assumption will need adjusting. Also, where a tenant has made improvements to the commercial property, a rent review should disregard the effect this has on the rental increase on the market. This would mean the tenant has to pay for the improvements again as their rent would rise in accordance with them.
3. Rent Review Clause
Further, the rent review clause should contain specific details about the review process. For example, not only will the rent review clause detail that it is an open-market rent review, but it should also detail any time factor for the rent review. This is crucial to understand as it can affect the tenant’s rights when the landlord reviews the rent with the open market rent clause.
The rent review clause will say whether time is of the essence or not. If time is of the essence, a commercial tenant must dispute the rate, where they wish to do so, at a specific time. Equally, a commercial landlord must carry out the rent review at the correct time. If time is not a crucial part of the rent review clause, it is not of the essence. This means that the landlord can review the rent for an open market rent review after the end date of the clause. This catches some commercial tenants out as they assume the landlord has chosen not to review the rent when instead, the commercial landlord will do so later in the lease term.
What Happens If a Landlord and Tenant Cannot Agree on the Reviewed Rent?
Disputes about the outcome of an open-market rent review are common. If a landlord and tenant cannot agree on the new rental figure, the rent review clause will usually set out a process for resolving the dispute.
Most commercial leases provide for the matter to be referred to either:
- an independent expert; or
- an arbitrator.
An independent expert is appointed to assess the market rent and make a determination. Their decision is usually final and binding on both parties. Unlike arbitration, the expert is not required to follow the rules of evidence and can rely on their own knowledge and experience.
Arbitration follows a more formal process. The arbitrator considers evidence from both parties and issues a binding award. Either party can challenge an arbitration award in court, but only on limited grounds.
The key difference is that an independent expert can be personally liable if they make an error, whereas an arbitrator generally has immunity. The rent review clause should specify which process applies and how the appointed person is selected if the parties cannot agree. Checking this before a dispute arises will save significant time and cost later.
This cheatsheet includes practical tips to understand key clauses and avoid disputes in leasing agreements.
Key Takeaways
Commercial leases will often have a rent review clause in the lease agreement. This allows the landlord to review the amount of rent their tenant pays. Rent review clauses will detail the type of rent review and other factors, such as how often a review can occur and its process. One type of rent review is an open-market rent review. With this type of rent review, the landlord will assess the rental amount by hypothetically calculating what they would get if the property was available on the open market.
If you need help understanding open-market assessment rent reviews, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our experienced leasing lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.
Frequently Asked Questions
What is an upward-only clause in an open-market rent review?
An upward-only clause ensures rent cannot decrease below its current level during a review, regardless of market conditions. This provision favours landlords by protecting their rental income throughout the lease term.
What is the difference between a cap and collar in a rent review?
A cap sets the maximum rent level achievable during a review. A collar sets the minimum, together creating boundaries within which the open-market rent assessment must fall.
What happens if time is not of the essence in a rent review clause?
The landlord can conduct the rent review after the clause’s end date. Tenants sometimes mistakenly assume the landlord has waived their right to review when the landlord simply intends to exercise it later.
Why must landlords disregard tenant improvements when conducting an open-market rent review?
Disregarding tenant improvements prevents tenants from effectively paying twice for their own upgrades. Including improvements would artificially inflate the market rent, unfairly increasing the tenant’s rent based on their own investment.
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