Rent-review hypothetical letting – A brief guide to making your future rent right

Our team: Roland Brandman

Part I – What to assume

You may currently have a lease, or have taken a lease in the past, with a term of 10 years or more. If so, it is very likely that the lease contains provision for the rent to be reviewed at some point (most likely at the end of the/every fifth year) so that the landlord can ensure that the rent keeps pace with increases in rents in the market.

Normally this is achieved by imagining that there is a “hypothetical letting” of the premises on the rent review date in the open market.

For these purposes, the lease will need to say what exactly are the deemed circumstances of the hypothetical letting. This is achieved by assuming certain circumstances and disregarding others (whether or not they might actually apply).

When taking a lease in the past, you may have been presented with a lease with a long list of assumptions and disregards, and perhaps you were not have been afforded any understanding as to what they might mean in practice (or why your solicitors might have spent so much time negotiating the wording of them).

This article is designed to give an introduction to the import of some of the usual assumptions.

The next edition of Quarter Day will contain Part II: an introduction to disregards.

Willing landlord and tenant

This is just about the most standard assumption you get.

The lease will say that when the premises are (hypothetically) put on the (hypothetical) open market, there will be a “willing landlord” and “willing tenant”. Because if there were no tenants whatsoever willing to take the premises (or indeed the landlord simply wanted to refuse to the let the premises) then the result would be no lease or the rent might be nil.

Let in whole or parts

Often a lease will say that the premises would be available to let as a whole or in parts, whichever produces the higher rent in the open market.

This means, for example, that if the lease is of a large unit, then notionally the unit could be split and let separately on a per-floor basis.

This one does not seem so fair, and will often be deleted by a tenant’s solicitor. The e tenant has actually taken up front a lease of the whole unit, so why should the tenant pay any more rent after rent review on the basis of a hypothetical tenant who has more flexibility from the per-floor basis?

A landlord might, however, argue that the assumption is fair if the lease allows the tenant to sublet part, as then in theory the tenant itself could sublet part at a higher rent. You be the judge of whether that is persuasive!

Vacant possession

It is assumed that the premises would be let with vacant possession. It is important to assume this, because at the review date the premises will in actual fact be occupied by the tenant, and what tenant wanting to operate its business from the premises would be prepared to take a lease of the premises at a decent rent, if any.

Premises fully fitted out / rent-free already expired

Although vacant possession is a standard assumption, the lease somehow needs to qualify what “vacant possession” means in the rent review context.

For example, “vacant possession” normally means that the unit in a shell-and-core state (i.e. with no tenant’s fixtures and fittings, so requiring a full fit out before trading can begin).

Landlords will often include an assumption in the draft lease that the premises are fully fitted out, which means that o the hypothetical tenant can immediately start trading (without incurring expenditure on works) and therefore cannot require a reduced-rent/rent-free period for fitting out time.

This is seen as rather landlord-friendly, and instead one usually sees an assumption that the revised rent will be at the rate payable after taking into account a rent-free period that would be usual in the market at the time (for fitting out purposes). This means that on review (at least in theory) the valuer should take such a rent-free period into account and spread that across the revised rent to give a lower rate. This is likely to be the fairer position given that the tenant probably would have had a rent free period at the start of its lease to reflect fitting out time.

It would also be fair to include an assumption alongside that the premises are “ready for immediate fitting out”, which is very different to saying that the premises have actually been fitted out and are “ready for trading”.

No fine or premium

To avoid an artificial distortion of the rent, it will be assumed as standard that the tenant has not paid the landlord an upfront capital sum on taking the lease (nor vice versa).

This protects the tenant against an argument that the hypothetical landlord would have paid a large lump sum to the tenant, which might then result in a larger ongoing rent.

Conversely, it also protects the landlord against the tenant arguing that the tenant might have paid a large lump sum to the landlord up front – rarer in real life – and so the ongoing rent itself would then be lower.

Hypothetical lease on same terms as actual lease

Exceptions to this principle are rare.

A landlord will sometimes try to draft in that the hypothetical lease would omit specific provisions which are in the tenant’s actual lease, but this would generally be an unfair attempt to punish the tenant twice – it forces the tenant in reality to comply with an onerous provision in its actual lease, but then pretends that the provision is not there for review purposes in order artificially to inflate the rent.

One example quite often seen is excluding any obligation on the tenant to remove alterations it has made at the end of the term. Often this would be dealt with in the diregards rather than assumptions, but either way the apparent unfairness is obvious. If a tenant would not have to incur costs removing its fitting out, then it might pay a higher rent. This might only seem a reasonable position for the landlord to take if the landlord has paid for the tenant’s works (notionally or actually). It is, however, one that still seems to be agreed a lot by tenants in practice, for not being “a major point”.

Permitted use

Another example of departing from the actual lease provisions is that sometimes a landlord will state that the premises can under the hypothetical lease be lawfully used for a wider range of uses (e.g. A1, A2, A3, A4 and A5) than the lease actually permits (e.g. just an A1 shop). That means the unit would suit a wider range of tenants and so might achieve a higher rent in the open market due to greater competition. This assumption should be strongly resisted. The normal fair assumption is that the premises may be lawfully used for the uses permitted by the actual lease.

Actual lease obligations have been complied with

A landlord will often try to include an assumption that both the landlord and the tenant have fully complied with their obligations in the actual lease.

In short, assuming the tenant has complied is normal, assuming the landlord has complied is often seen as unfair.

For example, if the tenant has wilfully damaged the premises, then it is only fair that on the hypothetical letting the premises are deemed to be in good repair, because otherwise the hypothetical tenant would pay a lower market rent (as the premises are damaged) even though this is due to the actual tenant’s breach.

On the other hand, it is not regarded as so fair to assume the landlord has complied with its obligations. If, for example, the landlord has breached its covenant to decorate the building (which might result in lower footfall and a less attractive unit) then why should it be deemed on rent review that the building is in a good state of decoration?! Sometimes a middle-ground is settled on which says that it will be assumed that landlord has fulfilled its obligations, except where the landlord has been in material or persistent breach.

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