Commercial Leasing Rent Reviews

Market rent reviews

Market rent reviews are typically assessed with reference to market rental assessments carried out by registered valuers. The standard process would be for a commercial landlord to obtain a market rent assessment valuation and if the market rent has increased, the commercial landlord would initiate a market rent review by serving a rent review notice to its commercial tenant accompanied by a registered valuer’s certificate setting out that valuer’s assessment of the new market rent. The Tenant would then have an opportunity to accept that assessment or propose its own market rent assessment. If the parties are unable to agree what the new market rent is, the market rent can be determined by expert determination (carried out by valuers) or by arbitration (again, typically by valuers but through a more formal private dispute resolution process).

The main benefit of carrying out a market rent review assessment is to ensure that the rent payable for the commercial premises is kept in line with the market rent payable for comparable premises in the region or area the commercial premises is situated. However, as market rent assessments are generally supported by professional valuation advice, the cost of obtaining those valuations may outweigh the benefit of carrying out such reviews too frequently, particularly if the annual rent is not high.

Fixed or stepped rent increases

Fixed rent increases are generally carried out annually or other agreed periodic intervals to a pre-agreed percentage increase. Stepped rent increases are similar but rather than using a pre-agreed percentage, the parties agree the actual increase that will occur on each stepped rent increase date. Fixed or stepped rent increases have the benefit of giving commercial landlords’ consistent rental growth while giving commercial tenants’ certainty as to what their rent costs will be year on year.

CPI rent reviews

CPI rent reviews peg rent increases* to the applicable inflation rate applying to the relevant review period and this is done by determining the movement of the consumer price index as a percentage. As CPI rent reviews are conducted with a pre-agreed formula using official CPI data, the CPI reviewed rent cannot be challenged except where there has been a calculation error.

As rent reviewed using fixed or stepped increases and/or CPI reviews can get out of step with market rent, most commercial leases adopt a combination of periodic fixed or CPI rent reviews with less frequent market rent reviews. Depending on the length of the initial term and any lease renewals, market reviews generally occur at the mid-point of the initial term and then on each renewal.

*Whilst it would be possible to have CPI rent reviews that allow for decreases in the event of a deflationary period, CPI rent review formulas found in commercial leases do not generally permit the rent to fall.

Rent review in retail commercial leases

In retail commercial leases, a common rent structure used is to have the commercial tenant pay the higher of base rent and percentage rent. The base rent is reviewed periodically using one or more of the above rent review methods, and the percentage rent is calculated on the basis of an agreed percentage of a commercial tenant’s gross sales. The benefit of this rent structure is that when the commercial tenant is doing well, the commercial landlord also gains by getting more rent. This model works best in retail malls where commercial landlords are incentivised to invest in the whole of the centre and ensure a good tenancy mix to attract retail customers.

What are rental ratchets?

Rent reviews may be subject to ratchets:

• A soft ratchet is where the reviewed rent cannot be less than the rent payable at the commencement date of the current term of the lease
• A hard ratchet is where the reviewed rent cannot be less than the rent payable immediately prior to the relevant review date

How do caps and collars work?

Rent reviews can also be subject to caps and collars:

• A cap is a set amount or percentage by which the reviewed rent cannot exceed after a rent review.
• A “cap and collar” allows the reviewed rent to go up or down but it cannot fall below a set amount or percentage (the collar) and cannot increase above a set amount or percentage (the cap).

Selecting the right rent review options is a balancing act

Given the various rent review options available, commercial landlords in each situation should determine what rent review options (and the frequency of those reviews) would strike the best balance between ensuring rental growth (particularly if there are funding costs to pay on the landlords’ side), the convenience (and cost) of carrying out each rent review, and the increases their commercial tenants can bear during the tenure of the lease.

Exercising the rent reviews

Commercial landlords should diligently diarise rent review dates and exercise rent reviews in a timely manner so they don’t miss out on rent increases from the relevant review dates. They should also ensure they follow the correct process for the type of rent review they are carrying out (having regard to the process as documented in their commercial leases) and record the reviewed rent in a deed recording rent review once the new rent has been agreed or determined. They should also remember to update your perpetual tax invoices to include the new rent amount.