APC Series: Rent reviews – the only way isn’t always up

Jen Lemen explores commercial rent reviews, how they link to the RICS APC pathways and competencies, and how APC candidates can write about them in their summary of experience. Rent reviews are a key component of the landlord and tenant competency. This requires candidates to manage the landlord and tenant relationship and covers all aspects of lease negotiations. Candidates are expected to understand the issues and how they affect both parties. This means that although a candidate may primarily act for landlords or tenants, they should be able to appreciate how they may advise a client if acting for the opposing party. Landlord and tenant is a technical (optional) competency for a variety of pathways, including commercial real estate, valuation and rural.  What should candidates know at level 1? Candidates should expect to find a rent review in the majority of commercial leases, save perhaps where they are very short in length. The purpose of a rent review is to rebalance the rent in line with the market.  Traditionally, institutional leases were much longer (around 20-25 years) and upward-only rent reviews (to open market rental value) allowed landlords to increase rents in line with inflation. However, these are becoming far less common, with typical lease lengths being three to five years and nil increase settlements being common where markets are stagnant. While upward-only rent reviews were historically the norm, the RICS Professional Statement Code for Leasing Business Premises has promoted the use of upward/downward rent reviews in lease renewals and new leases. This means that the rent can go up or down at rent review, rather than either going up or staying at the passing (rack) rent if the comparable evidence supports a nil increase. If the evidence supports a rent below the passing rent, then an upward-only review clause will prevent the rent from going down, ie the rent will be the higher of the market rent or that passing. As well as open market rent reviews, there are other bases found in commercial leases, such as index-linked (to RPI or CPI), turnover-linked or stepped/fixed increases. Turnover rents are common in shopping centre leases and may be geared to the type of tenant, and index-linked rent reviews are common for convenience stores. The latter are often collared and capped, for example at 1% and 4% pa. Apart from agreeing the instruction and undertaking pre-instruction checks, the first step when dealing with a rent review is to check the lease and prepare a lease summary. This will detail the general lease terms, as well as the following specifically in relation to the rent review: Rent review date; Passing rent; Rent review basis; Whether time is of the essence; If open market basis, the hypothetical lease terms and lease length, assumptions and disregards; Third-party provision, ie arbitration or expert determination, who can make the election and any cost provisions (if expert determination); and Penal interest provisions, for example a certain percentage above base rate after a specified period of time. After summarising the lease, for an open market rent review the candidate will need to assess market rent on the basis of the hypothetical lease terms, assumptions and disregards. There is no standard basis, and candidates will need to become very familiar with analysing often complex review bases. A typical assumption might relate to the state of repair, while a typical disregard may relate to goodwill or tenant’s improvements. This will then allow the candidate to assess market rent, based on the hypothetical lease terms and available comparable evidence.  Another key consideration is to check if time is of the essence, in line with United Scientific Holdings Ltd v Burnley Borough Council [1977] 2 EGLR 61. The general presumption is that it will not be, unless there are specific indications to the contrary, for example express wording or surrounding circumstances. The impact of time being of the essence is that if the specific timings are not adhered to, such as service of notice, then the right to review will be lost.  Finally, a candidate will need to consider their negotiation strategy in their client advice. This will include consideration of the third-party procedure, service of trigger notices and settlement parameters. In relation to third party, there are two main procedures stated in leases: arbitration and expert determination. Candidates often confuse the latter with an expert witness. In summary, an independent expert is a third party who determines the outcome of a rent review if the parties cannot agree. An expert witness is the role that each surveyor (ie acting for the tenant and for the landlord) adopts when they go to third party.  The advice will need to be updated as the review negotiations progress, to include the service of Calderbank offers or service of a DRS 1 application to appoint a third party.  Calderbank offers are another source of confusion for candidates. A Calderbank offer will be labelled “without prejudice save as to costs”. It will include a genuine offer to settle the rent review dispute without recourse to third-party proceedings. It can also be used to protect a client’s position on costs (for example before submitting a DRS 1 application form). The offer must be valid and include a proposed rent and timescale for acceptance, typically 21-28 days. The offer must be made with the client’s written approval, as it is legally binding if accepted. On this basis, it should always be double and triple checked before being served. After negotiations (or third-party proceedings) have led to an agreement, award or determination on the new rent, then the parties need to document this in formal rent review memoranda. This can then be appended to the lease to avoid any future confusion over the level of rent. What experience do candidates need at levels 2 and 3? Ideally, a candidate taking landlord and tenant to level 3 will declare two examples in each of levels 2 and 3. At both levels, ideally one of these examples will be a rent review. At level 2, candidates can assist or shadow a more senior surveyor, or possibly take responsibility for specific parts of a rent review instruction. This could be the reporting or negotiation stage, for example. At level 3, candidates need to have dealt with a rent review from start to finish. Ideally, this will not have been a simple nil increase or an index-linked rent review and will have had an aspect of complexity. This could have been negotiation of a new rent based on the comparables, interpretation of the hypothetical lease terms, involvement with third-party proceedings or advising on a negotiation strategy (for example a Calderbank offer).  The quick quiz (answers below) 1. How do RPI and CPI differ? a) RPI includes mortgage interest payments b) CPI includes mortgage interest payments c) RPI includes housing rental payments 2. What ADR method is proposed for use with Covid-related rental arrears?  a) Expert determination b) Arbitration c) Adjudication 3. What is RPI currently running at (correct as at 23 March 2022)? a) 8.2% b) 7.8% c) 8.7% Professional guidance alert RICS Guidance Note – Planned Preventative Maintenance of Commercial and Residential Property: https://www.rics.org/uk/upholding-professional-standards/sector-standards/building-surveying/planned-preventative-maintenance-of-commercial-and-residential-property/  RICS Independent Review – Review of Real Estate Investment Valuations: https://www.rics.org/uk/upholding-professional-standards/sector-standards/valuation/review-of-real-estate-investment-valuations/  RICS Guidance Note – Boundaries: procedures for boundary identification, demarcation and dispute resolution: https://www.rics.org/uk/upholding-professional-standards/sector-standards/land/boundaries-procedures-for-boundary-identification-demarcation-and-dispute-resolution-rics-guidance-note-4th-edition/ Further reading and resources RICS Guidance Note – Surveyors Acting as Arbitrators in Commercial Property Rent Reviews: https://www.rics.org/uk/upholding-professional-standards/sector-standards/dispute-resolution/surveyors-acting-as-arbitrators-in-commercial-property-rent-reviews/ RICS Guidance Note – Surveyors Acting as Independent Experts in Commercial Property Rent Reviews: https://www.rics.org/uk/upholding-professional-standards/sector-standards/dispute-resolution/surveyors-acting-as-independent-experts-in-commercial-property-rent-reviews/ RICS Practice Statement and Guidance Note – Surveyors Acting as Expert Witnesses: https://www.rics.org/uk/upholding-professional-standards/sector-standards/dispute-resolution/surveyors-acting-as-expert-witnesses/ Jen Lemen BSc (Hons) FRICS is a partner at Property Elite Photo: Paul Brennan/Pixabay Quiz answers: 1: a   2: b   3: a