11 January 2022 #Commercial Real Estate
The subject of rent review is immensely complex and many articles and books have been written solely on this topic. In this short article we are highlighting rent review points from two transactions where we have acted for the prospective tenants and were asked to advise whether the wording of the rent review clauses had a disadvantageous effect on the tenants in question.
Assumption regarding permitted user
When a lease is being negotiated, the parties and their agents and solicitors will consider whether any terms of the lease are onerous. Onerous terms have an effect on both the landlord and the tenant, although in completely different ways.
For a tenant, onerous covenants may mean that the tenant is obliged to comply with unreasonable restrictions during its occupation of the premises and may, when it wishes to assign the lease or sublet, find it more difficult to locate a party who is willing to take on the premises.
For a landlord, onerous conditions in the lease may be beneficial in that they enable the landlord to keep a tight control on what the tenant is able to do at the premises but with the disadvantage that an onerous condition may have an adverse effect on rent review, meaning that the landlord will gain a lower rent at review than might otherwise be the case. This is because a lease with an onerous clause will be regarded as being less attractive on the open market than one without such a clause.
On our first transaction we were instructed on a new lease of retail premises where our client intends to sell ladies clothes. Usually the rent review provisions in a lease will provide that the rent review is to be upward only (so that the landlord does not have to bear the risk of rents falling) and the rent is to be calculated on the basis of similar terms and conditions as the existing lease. This means that if there is a user clause permitting A1 User (retail use), then the lease will be reviewed on the basis that the premises are allowed to be used for any retail use instead of only the very specific use for which the tenant actually uses the premises.
Unusually in the lease in question, the landlord’s solicitors provided a draft lease which stated that the permitted user was 'sale of high quality ladies wear only' instead of the more usual 'use within Class A1'. Such a user covenant would be very restrictive user covenant for a tenant, as it will limit the number of potential assignees if the tenant decides to dispose of the premises. The restriction would also prevent any alternative use by the tenant himself. A user covenant worded in this way will also have a very disadvantageous effect for the landlord on rent review if it is incorporated into the rent review clause.
To avoid any disadvantage to the landlord, the landlord’s solicitor had drafted the lease to provide that notwithstanding the fact that the permitted use was sale of high class ladies wear only, the rent review was to be calculated as if the lease for the property contained a full A1 user clause. This means that the tenant has a double disadvantage in that:
This is an example of very unfair provision and tenants should strongly argue against clauses of this type !
Fit and ready for immediate occupation and use?
A standard assumption in a lease when calculating the new rent on a rent review is that the demised premises are fit and ready for immediate occupation and use. Is there any concern about this wording?
If this wording truly reflects the nature of the premises so that the tenant was able, when the lease was completed, to move in and immediately start working from the premises (as may be the case with some offices) then there should be no problem with this assumption as it is merely reflecting the actual situation.
In the lease of new premises where we recently acted, the proposed tenant was taking a former retail unit for conversion to a restaurant. The tenant intends to fit out the premises and the fit out will be very extensive and expensive (the cost here was in the region of £500,000). In this situation, the use of the assumption wording “fit and ready for immediate occupation and use” will result in the tenant’s own fit out being rentalised on review, notwithstanding that the tenant will be carry out its fitting out works at its own cost and not the cost of the landlord.
Although this assumption may be counterbalanced by the usual disregard on rent review of any tenant’s “improvements” which have been carried out at the expense of the tenant, it is preferable to amend the assumption wording so that it reads:
“The Property is ready to be fitted out by a willing tenant”
This wording will make it clear that any fit out works, whether or not “Improvements” are not rentalised on review to ensure that there are no arguments over what is or is not an improvement.
As some leases allow some works may be carried out without landlord’s approval, tenants should ensure that they accurately document all works that they carry out so that there is clear evidence at the review date of all works carried out by the tenant at its own cost to ensure that these works are not rentalised on review and the tenant does not pay a higher rent than it should.
The points discussed above are just two of the many of issues that arise when negotiating a rent review clause. If in doubt about rent review provisions in your lease please contact our specialist commercial real estate lawyers.