In setting out the best possible rent review options for different sectors, GVA has analysed existing lease agreements in the UK and found RPI rent increases to be a damaging alternative.
At a seminar held for clients at St Catherine’s Court in Bristol, GVA’s lease consultancy team explained how the combination of much shorter average lease lengths, a severe economic recession and relatively high inflation has dramatically changed the options for leases, taking into account the interests of both landlords and tenants.
Recent research shows that, in recent years, there has been a significant evolution of commercial property leases, with average lease lengths in the current economic climate now below five years, compared to the standard rate of 25 years in the late 1980s.
For those occupiers on longer leases, this year marks the first rent review for the many leases signed at the height of the market in 2007. Since then, average rental values have fallen by as much as 30% in some markets, although with traditional upwards only rent reviews (UORRs), most leases won’t reflect this adjustment.
More recently, there has been a growing trend for rent to be linked to an index such as RPI inflation. Since 2007, RPI inflation has increased by 18% and is forecast to rise another 13% by 2017.
This method of adjusting rent has therefore become a popular alternative with investors as it guarantees a continual increase in rental income compared to the up and down nature of rental values. However, any tenant signing on these terms in 2007 could now be paying 25-50% over current market rental values.
Over the long term, RPI inflation linked leases are potentially very damaging for a tenant’s business, more so than those on UORR terms and it makes assignment or subletting virtually impossible and increases the chances of default or break clauses being taken for the investor.
GVA director and retail specialist Jerry Burton advises, “Many occupiers misunderstand the nature of UORRs which remain unchanged if rental values have fallen at the time of review. Throughout the South West and South Wales many occupiers on existing long leases on UORR terms still pay the same rent today as they did in the late1990s.
“Whilst some retail locations such as Bridgwater have experienced a period of stagnation over this time, other prime locations such as Exeter, Bristol, Cheltenham and Cardiff have seen substantial reductions in rental value.
“Despite the well-publicised problems affecting the market, the region does have some hotspots though – these include Wells, Cheltenham’s Promenade, Cirencester and Newquay, where values have risen.”
GVA director Stuart Powlesland adds, “Even in the commercial markets of offices and industrial, there are a number of locations which are still experiencing growth – Cheltenham, Bath, Torquay and parts of Bristol. This is due to the lack of supply in the new build sector, the continued growth in land values or in locations which had not experienced the same spike of rental growth in the pre-recessionary years and have a continued level of sustained growth.
“The market is becoming polarised between the prime and secondary locations, with the secondary stock becoming obsolescent very quickly due to occupiers coming out of this type of accommodation.”
The one measure that does not formally exist as a recognised type of review is the upwards / downwards open market review. However, as over two thirds of all leases are below five years, upwards / downwards review has been incorporated through the back door. Many occupiers are using short leases to create flexibility and avoid rent reviews and taking a hedge that open market rental values will be lower at the end of the term than when they were signed.
Jerry concludes, “On a balanced basis, we think that the UORR still has an important role for longer leases and should continue if only to maintain an equal level of fairness that recognises the cyclical nature of property compared to RPI inflation. For an investor, it provides a guarantee that the level of income will not fall, whereas for the tenant it provides a much greater degree of protection to over renting than RPI inflation linked leases when rental values are in decline.”
GVA’s latest research assesses the advantages and disadvantages of the UORR, which alternatives landlords and occupiers can now use to best suit both parties and the outlook for rent reviews this year and in the future.
