What goes up …

Elizabeth Thompson reports on retailers’ disenchantment with upwards-only rent reviews


Upwards–only rent reviews (UORRs), as highlighted by the Labour Party 2001 Business Manifesto, are “a source of grievance to many in the business community”. If landlords are concerned with working alongside their ‘customers’ over the five-yearly headlock on rent review, a solution needs to be found. The Government has put forward five: an outright ban; a ban subject to a proviso that rent cannot fall below the initial level; a right to break if the UORR produces a rent above open-market levels; a limit on lease length; and a mandatory requirement for landlords to offer priced options to prospective tenants.

Retailers will welcome the Government’s determination to find a solution by issuing its consultation paper now, but the solutions warrant scrutiny; the apparently limitless upside for retailers could prove illusory. The landlord scare stories of no new investment and higher initial rents contain some truth.

For many retailers, UORRs are an unacceptable shift by landlords (and their funders and lenders) relating to the risk of downward market volatility. But their regulation should not be achieved at the expense of other benefits in leasing arrangements.

Solution four is the most serious offender in this category. The Government envisages that lease terms longer than five or 10 years should be deemed to be unfair contracts, thereby eliminating or curtailing UORRs.

The average length of lease term in the retail sector has become shorter in recent years, but anchor tenants in shopping centres, supermarket tenants and leisure/fitness tenants, for example, all need lease terms in excess of 10 years to make their substantial plant, machinery and human capital investments viable. Writing down allowances on their fitting-out expenditure, in particular, is an integral element of their financial appraisals. Second, where planning permissions are in short supply, retailers want long terms and security to fend off competition; renewal rights are a second-rate option.

Additionally, well-advised landlords faced with regulation will seek to exploit any loopholes in the legislation; for example, put options to force tenants to take up subsequent reversionary leases.

Solution three also falls into this category. UORRs without an operable break clause linked to the timing of the review would be deemed unfair contracts. It would tighten the headlock at a rent review still further, especially where the uplift in rents was marginal.

Retailers seek unconditional break clauses on a selective basis to give them flexibility. They have always had an expensive price tag and are no longer Stamp Duty Land Tax-efficient. Imposing them mandatorily to mitigate indirectly UORRs’ effect is a primitive solution, which may lead to higher initial rents.

Solution five would give legislative teeth to the existing voluntary code of practice to the same effect. The Government has acknowledged that it would be very difficult to police and enforce.
Experienced retailers will see little value in this; their desire is to eradicate the dependency of the commercial property market in England and Wales (in contrast with mainland Europe) on UORRs in sustaining investment values.

Solution one would achieve this at drawing board stage, but in practice few retailers would escape the ‘hangover’ from the present regime on their existing leasehold interests. The effect on the marketability of existing leases with UORRs would be hard to predict and would be linked (inevitably) to the impact on rent reviews in those older leases.

Solution two is a sibling of solution one but a less extreme one, and for this reason more attractive. UORRs would be deemed to be unfair contracts, but landlords would be entitled to require rent at the initial rate agreed, if a subsequent open market review determined a rent below that rate. The ‘hangover’ for existing leases with UORRs would be less profound and the consequential increase in initial rent payments less onerous. But, like all halfway houses, it would be a curate’s egg, leaving significant anomalies.

As ever in a dynamic market, the biggest danger is prolonged uncertainty. Retailers facing competition for sites will still chance their arms and continue to sign up to UORRs. Others will hold back in hope, although the market may stagnate.

Elizabeth Thompson is a property PSL at Berwin Leighton Paisner