The perfect opportunity to follow Europe’s lead of index-linking rents is being sidelined by the government’s new code of practice. By Richard Pelly
The new Code of Practice for Commercial Leases in England and Wales recommends that reviews should generally be to open market rent, but that wherever possible landlords should offer alternatives priced on a risk-adjusted basis. The two mentioned are up/down reviews to open market rent with a minimum of the initial market rent, and indexation.
The government may have given insufficient consideration to the advantages of index-linking. But there is still time to stabilise an increasingly uncertain market.
A European perspective
Throughout continental Europe, index-linking is commonplace:l reviews normally take place annuallyl it seems successful in setting rents in economies of differing strengths. l it has proved sufficiently flexible to be effective when using different indices, and at different stages of the market cycle. l it is effective where there are marked variations in regulations and tax.
Significantly, European institutional investors are willing to offer UK tenants an index-linked review, for example, on sale-and-leasebacks. Index-linking smooths cash-flow for the tenant long term, and the landlord can negotiate a tougher alienation clause. In a depressed/deflationary market, index-linking is also profitable.
To assess the viability of index-linking rents in England and Wales, it is useful to look at rent reviews elsewhere in Europe.
France
Occupational lease rents are set initially with reference to the market rent and are paid quarterly in advance. Reviews are annual, indexed to the Cost of Construction Index. The term is typically nine years with a break option every three years. Assignment and subletting are subject to the landlord’s approval but this is usually restricted. There is a statutory right to renew.
Germany
The rent is set at the market rent, payable monthly in advance. It is indexed to the Lebenshaltung Kostenindex – the German cost of living index. Leases are usually between five and 10 years with break options subject to negotiation. The tenant cannot assign but may sublet with the landlord’s approval. There is a statutory right to renew.
Italy
Shorter terms of six years with an automatic right for the tenant to extend for a further six years apply here. Breaks are negotiable. The market rent, payable quarterly in advance, is indexed to the ISTAT, the Italian cost of living index. Annual increases in rent may not exceed 75% of the index. Assignment and subletting are usually prohibited.
Spain
Indexing or periodic review apply here. Office lease lengths vary between three and five years, retail between 10 and 15. Breaks are negotiable. The market rent, payable monthly in advance if indexed, is linked to the consumer prices index and reviewed annually. If the rent is reviewed periodically, reviews typically take place at the end of the third and fifth years. Assignment or subletting generally entitle the landlord to an increased rent.
Scandinavia
Lease lengths vary between three and 10 years. In Denmark, Finland and Norway there is a statutory right to renew. Break clauses are negotiable in Denmark and Norway, rare in Sweden and non-existent in Finland. The market rent is payable monthly or quarterly in advance.
In Denmark and Norway, rents are index-linked to the CPI. In Finland, the rent is indexed to the cost of living. Leases of less than three years may not be index-linked in Sweden and occupational leases do not normally contain a review. Instead, the market rent is set at the end of the lease by negotiation, but leases generally have an annual index-linked clause.
In Belgium, Greece, Portugal and Poland, lease agreements are being negotiated that adopt an inflation/index-linked review provision. Austria, Belgium, the Czech Republic, Hungary, Romania, Switzerland, The Netherlands and Turkey also use a similar rent valuation formula.
Is it too late?
There can be no doubt that index-linking would work as well in England and Wales as it does elsewhere in Europe. But without legislation compelling them to do so, the landlords will not agree.
This is the message to landlords: index-linking is good for business, it works throughout continental Europe, and it works in the UK. It would be good for UK plc. The government, despite the code, is not yet committed to its present course. There is still time to act.
Richard Pelly is an assistant solicitor at Chelmsford-based Gadsby Wick
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Index-linking |
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Quicker system with benefits of forward planning |
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The landlord or tenant may gain depending upon whether open market rents rise faster or slower than the chosen index. If rents rise more quickly, the landlord loses; if rents rise less quickly, the landlord gains. Out goes the time-consuming and expensive independent determination rent review process. Landlords can forward-plan. The “boom and bust” review cycle is replaced with a simplified, less expensive, and more certain procedure. Tenants are better able to predict their future fixed business costs in the medium to long term. The destructive current system of upward-only reviews every three to five years would disappear overnight for new leases. Fewer tenants would be forced to forfeit because of massive rent hikes, thus reducing unemployment and market uncertainty. |