A 75% fall in rents in the last recession left bitter memories in the minds of many. Now that the market is once more vibrant, are practitioners ready to tackle rent reviews again? By Stephen Lines
City rent reviews have moved on since they were last seen as a market activity at the end of the 1980s, with changes in both conditions and working practices. This increased activity has really come to life since 1996. There is still some way to go before rent review work reaches the peaks attained in 1989, but rents are now at levels last seen around 1987. This implies that not every building is or will be subject to rent review, and that things remain patchy.
In fact, active rental negotiations are generally occurring on:
- rents agreed through lettings in the trough of 1992;
- renewals of historic leases coming to an end where high levels of rent are being paid;
- where tenants are exercising options to determine that were renegotiated in leases agreed when market conditions were softer and landlords had to give away no end of incentives to attract occupants.
Suddenly the market is seized with workloads resembling times almost forgotten, but what of the rent review teams who used to operate in those happy days? Most were dismantled in the early 1990s as rent review negotiations dried up in the face of the rapidly deteriorating letting market. Some teams diversified, involving themselves in the 1990 and 1995 rating revaluations. Others turned to valuation and consultancy.
The City is now genuinely short of experienced professionals in the sector and many firms – but by no means all – are attempting to recruit so that they can deal with the new volume of instructions. The market is, however, missing the “lost generation” of experienced practitioners who made permanent moves into other areas, geographically or in discipline terms.
Sustainability
The great fear for some old stalwarts is whether the market is sustainable in the long term, and whether rent reviews will disappear over the next few years as quickly as they re-emerged. Some firms are predicting a return to a dormant market with falling rents in the wake of the economic slowdown.
However, while the comparatively phenomenal rental growth seen recently will probably not last, unlike in the late 1980s, the current lack of supply of new and decent secondhand premises will allow rents to remain relatively buoyant. This factor, coupled with the greater number of aged long leases expiring in the future, should ensure that rent review surveyors will be in work for some time to come.
Pessimists, however, can turn to recent press coverage suggesting that the London economy, separate from the rest of the UK and bigger than that of Austria, may be heading for a post-millennium hangover.
Compared with 10 years ago, rent reviews are now being conducted against a structurally different market background. New lettings are generally being agreed with comparatively minimal rent-free periods of no more than six months under leases of up to 10 years, and the task of rent review surveyors acting for both landlords and tenants is to grapple with this market evidence to arrive at reasonable net effective levels of rent, having regard to lease rent review provisions.
These provisions may or may not give specific guidance as to treatment of rent-free periods. Indeed, leases now subject to review agreed five years ago – granted on more advantageous terms to tenants with options to determine, capped service charges and VAT indemnities – are now coming back to haunt occupiers.
In theory, such lease terms agreed in a softer market will transfer into higher rents being paid than true market levels, where landlords no longer have to give away incentives such as long rent-free periods. Tenants nowadays will pay premium rents to gain flexibility in lease terms, including options to determine. Leases also now come with new privity rules under the Landlord and Tenant (Covenants) Act 1995.
What of third party referrals? The Dispute Resolution Service of the RICS has recently reported that applications for appointments of arbitrators and independent experts in commercial rent review disputes are up from a low of 4,578 in 1995 to in excess of 5,000 applications in 1997, and expected to grow further this year. Yet this is still well below the peak of 14,748 applications received in 1991. Clearly, recent rent review activity is filtering through to third party referrals as tenants try to keep a lid on rent increases in a rising market by making early protective applications.
New rules also now apply on arbitral disputes under both the Arbitration Act 1996 and Civil Evidence Act 1995, specifically in relation to the facility for the parties to establish procedures, and the admissibility of hearsay evidence on compliance with certain rules. After the initial ground rules are agreed or established by the arbitrator, references are conducted in much the same way as before, except that awards supported by reasons are now mandatory. Arbitrators are also being expected to improve their qualifications with the requirement to have gained a formal Certificate in Arbitration, to be phased in by the beginning of 2002.
It will not be too long before the first rent reviews take place on so-called low rates properties – new developments completed after April 1 1995 which escaped transitional phasing liability. Landlords will undoubtedly attempt to apply a rent/rates equation on occupational costs, excluding service charge, to imply a higher level of rent than would otherwise have been agreed with conventional phased rates.
This will undoubtedly include some of the buildings now completed for occupation after preletting, but subject to review on completion, such as Robert Fleming’s new headquarters at Barrington House, Gresham Street. The highest rents agreed on lettings have been over £50 per sq ft (£538 per m2) and it remains to be seen whether landlords can reproduce such levels through rent review negotiations within the artificial constraints of the rent review provisions. In contrast, some tenants are still paying this rent for secondhand space which would still be above market levels today.
A note of caution should be struck on the negotiation of rent reviews in the new era. As a discipline, rent review discussions and agreements must be commercial, expeditious and, above all, seen to be what the parties required when they took out the lease five years ago – a simple exercise to agree a fair rent to reflect current levels that would have been agreed if the premises were let on the open market, and without undue fuss and unnecessary professional charges. Failure to secure these goals will leave the lease drafters and rent negotiators open to criticism.
If rent reviews are perceived as becoming unreasonably burdensome, tenants may resist taking longer-term leases with rent reviews. This may be at the cost of having to agree a higher rent in the short term, but this benefit will work against landlords in the longer term.
The strong market conditions seen at present will not last forever and tenants may resist being forced into agreeing to long leases where future rent reviews may cause uncertainty and result in acrimonious disputes with landlords. This may see a change to perhaps rental indexation, or a general reconsideration and simplification of rent review and lease renewal practice and procedures.
A realistic approach by both parties will perpetuate the notion of the commercial acceptability of a longer lease with rent reviews.
|
A Selection of Larger City Properties which are, or may be, subject to rental negotiations |
|
EC1 Holborn Bars, 138 – 142 Holborn (former Prudential Assurance HQ) Finsbury Dials, 20 Finsbury Street |
|
EC2 99 Bishopsgate Winchester House, 77 London Wall (rent review on completion) Broadgate City Place, 55 Basinghall Street Moorgate Hall, 143 – 171 Moorgate |
|
EC3 Lloyd’s Building, 1 Lime Street 122 Leadenhall Street (the former P&O building) CU Tower, 1 Undershaft Five Acre Square, Houndsditch New London House (adjacent to Fenchurch Street Station) Minster Court (including the London Underwriting Centre) |
|
EC4 Ludgate/Fleet Place 1 King William Street (rent review on completion) Vintners Place, Upper Thames Street |
Stephen Lines is City office partner at King Sturge
