UK Real Estate: An end to upwards-only rent reviews?

A long-discussed issue

A proposed ban on upwards-only rent reviews (“UORRs”) is nothing new, and has been the subject of discussion within the UK property sector for many years.  Until now, there have been no meaningful moves towards legislating against UORRs, largely because (whatever your perspective) it means interfering with the commercially-negotiated terms between business owners (the landlord and the tenant), and the industry has never found a suitable substitute for the rent review mechanism. 

In an article published by the Ministry of Housing, Communities and Local Government to accompany the new Bill, the Ministry suggested that UORRs “pit landlords against business and can make rents unaffordable and cause shops to shut”. Landlords and their representative bodies might argue that it’s not in their interest to drive up rents to the point that they lose their tenants and rental income, and that UORRs are vital to provide predictable income streams, particularly for institutional investors, and (in turn) to drive investment into the real estate sector. 

UORRs are also perhaps less of an issue. In particular, average lease lengths have reduced significantly (meaning fewer leases containing any kind of rent review clause).  That is particularly the case in the retail sector, where small business owners will commonly take leases for short terms of 5 years or less, without rent review provisions.

How the proposed ban would operate

The Bill has only just been launched, and the draft provisions will need scrutiny not just by Parliament but also by way of consultation with industry stakeholders, who are bound to have much to say on the issue. 

We’ve taken a look at the current draft to see how the ban might operate, what has been done to close potential loopholes, and what major issues remain to be addressed.

• The new law would take effect by the addition to the Landlord and Tenant Act 1954 (“LTA 1954”) of a new Schedule 7A, a draft of which can be found in Schedule 31 to the Bill.
• As drafted, the ban would apply only to leases to which the LTA 1954 applies. That is to say, leases held by tenants occupying their premises for business purposes. The ban will apply regardless of whether the parties have contracted out of the security of tenure rights under LTA 1954.
• The provisions would be prospective only. They would apply to leases granted after the new law comes into effect, including any renewal lease granted after that date pursuant to LTA 1954 . Existing leases would not be affected.
• Where a new lease purports to provide for an upwards-only rent review, whether by reference to inflation or another form of indexation, or by reference to the prevailing market rent at the review date (what the Bill describes collectively as the “reference amount”) statute would cap the reviewed rent by reference to that reference amount. In other words:
  • Rent reviews can be index-linked, but on the understanding that if that index moves negatively, the reviewed rent would then be below the passing (pre-review) rent.
  • Rent reviews can be made by reference to the market rent prevailing at the date of the review, but will be capped at that market rent, so that if the market rent is below the passing rent the reviewed rent will move in a downwards direction to match that lower market rent.
• The draft legislation contains wide-ranging anti-avoidance provisions. For example, a landlord cannot avoid a downwards rent review simply by deciding not to serve a rent review notice on their tenant. Under the proposed legislation, all tenants to whom the provisions apply will be able to serve notices to trigger the rent review, where their landlord fails to do so. This appears to be an attempt to plug some of the “loopholes” identified by the Irish experience, where UORRs have been banned for many years.

Our thoughts

Aside from this legislation catching the real estate industry by surprise, and being introduced without consultation, we’ve cast an eye over the draft legislation and have spotted a few substantial points that will require further thought.

• According to the Ministry, the provisions are intended to address vacancies on high streets and support small retail businesses. But because they are expressed to apply to all business tenants to whom the LTA 1954 Act applies, they will benefit all commercial property tenants, including the occupiers of offices, retail parks and even industrial and logistics properties. As noted above, the occupiers of high street shops are perhaps amongst the business tenants least likely to have rent review provisions in their leases.
• Conversely, applying the ban on UORRs only to leases to which LTA 1954 applies means that entities holding head-leases or intermediate leases will not be afforded the same protections as their occupational sub-tenants. Occupation is a prerequisite for protection under LTA 1954, which means that whilst the occupational tenant’s landlord will not be able to enforce an upwards-only rent review against them, that landlord may be exposed to an upwards-only rent review by their own, superior landlord. That will obviously leave an income gap, with the prospect of the occupational tenant paying less rent than their own landlord is paying.
• If these provisions are enacted unaltered, an index-linked rent review might be seen as a more secure investment for landlords, albeit that rents could still fall if the index falls. But adopting that cautious approach could deprive investors and landlords of the ability to claim on review a rent that is a true reflection of the (higher) rents payable in the market at that time.

Industry concerns

As noted above, this new legislation is at a very early stage and we will have to wait and see what MPs and Peers make of it as the Devolution Bill passes through Parliament. With the remainder of the Bill having little or no connection with the level of rents in commercial property, specific scrutiny of section 71 and the proposed new Schedule 7A will be required from Parliamentarians and industry specialists so that a significant change in the law and a fundamental re-basing in the landlord and tenant relationship isn’t rushed into law without the fullest consideration that it needs. 

There is no doubt that a ban on upwards-only rent reviews would have a significant impact on the commercial property market, and not just the retail sector.  The full impact on investor confidence and on investment in the property sector in general hasn’t yet been the subject of a full consultation, and it goes without saying that industry voices on both sides of the table will now need to proactively engage Government and Parliament to shape the final legislation. Our award-winning tier-one Public Law and Policy team has a great deal of experience of this, so please let us know if we can help.

Authored by Tim Reid.