Government proposes the abolition of upwards only rent reviews in new commercial leases in England and Wales

On 10 July and with no previous consultation, the UK government unexpectedly introduced a proposal to ban upwards only rent reviews in most new business leases. Despite being buried away at the back of the draft English Devolution and Community Empowerment Bill, the measure has the potential to have a significant impact on the commercial lettings market.

Upwards only rent reviews have long been a fundamental, defining feature of UK commercial leases. Their presence has always been a key part of what makes a lease institutionally acceptable to investors, providing assurance that the capital value of the reversion is maintained, even in a falling market. Their abolition, if it takes place, would signal a fundamental shift in the basis of UK commercial leasing which could potentially impact the value of commercial lease portfolios.

Which leases are in scope?

The provision will apply to new commercial leases in England and Wales occupied by business tenants (unless entered into pursuant to an agreement for lease prior to the legislation coming into force) which include rent review provisions where the amount of any new passing rent is not known and cannot be determined when the tenancy is granted. This will include lease renewals whether under the Landlord and Tenant Act 1954 or otherwise.

Rent reviews by reference to actual or hypothetical market rent, turnover rent or index linked changes will be caught by the prohibition. Pure fixed stepped rents will not.

Regulations may provide for exceptions. However, the guidance accompanying the bill says these exceptions will be very limited and specifies only agricultural tenancies as an exception. It appears from the bill's explanatory notes that the government envisages the introduction of possible exceptions, under regulated parameters, to allow  some use of "caps and collars" in commercial leases. The government has indicated that it is unlikely any exceptions relating to "caps and collars" would be in place at the time the ban becomes law as it needs to consult on the options for their use.

As an anti-avoidance measure, the bill also introduces a parallel prohibition applying to contractual "put options" entered into after the ban comes into force, which require tenants of existing tenancies to take a new lease of the whole or part of the premises currently let to them.

What will the effect of the ban be?

Through amendment to the Landlord and Tenant Act 1954, upwards only rent review provisions within in-scope leases will be unenforceable. The new rent will be determined by the methodology provided for in the lease, save that any "upwards only" ratchet will be removed. Therefore, the new passing rent may be higher, lower or the same as the pre-review rent.

Can the parties get around the ban?

The anti-avoidance provisions (as currently drafted) are broad and state that any agreement is void if or to the extent that it purports to do so. Tenants are also to be granted more control over the rent review process, with the power to initiate a rent review where trigger action is needed or to take action to enable the review to operate more effectively, but the tenant does not have existing rights to do so under its lease.

Will the ban really make it in to law?

The proposals are intended to offer further support for small and high street businesses but they will capture those operating in a much wider range of sectors. Given the potential breadth and depth of the ban, they will be widely opposed by investors. However, the possibility that the ban will pass into law cannot be discounted.

Passing the measure into law, however, may not be entirely straight forward. The government has acknowledged it is likely to engage aspects of human rights legislation, although the government's view is that its approach is proportionate and balances landlord and tenant interests. Challenges from landlord and investor stakeholders nevertheless seem highly likely.

Osborne Clarke comment

Against an increasingly challenging regulatory and economic backdrop, removing upwards only rent reviews will no doubt be welcomed by tenants but has already been met with concern by commercial property investors.

It is likely to impact the terms and costs of financing for commercial development and investment acquisitions. It may be that investors consider turning to other avenues for income such as operational assets where income is based on licences and provision of services or possibly also residential development, although the regulatory landscape and supply chain issues for the latter bring their own challenges.

We might see landlords pricing in higher fixed rents on the grant of a tenancy to negate the impact of the abolition, which would defeat the purpose of its introduction and prevent the  use of risk sharing models. We may perhaps see a move to shorter leases without rent reviews, which, under current proposals, could also offer landlords escape from security of tenure. There may also be an increase in the use of stepped rent provisions. Turnover rents may also become less attractive to landlords if reserving a  minimum base rent is no longer legally enforceable. As the ban does not catch leases granted pursuant to binding agreements entered into before the ban comes into force, these agreements are likely to come under increased scrutiny by tenants.

While it is not certain when or if this measure will become law, landlords may wish to consider its potential impact now and update valuations against a revised set of assumptions accounting for the abolition. This should include an assessment of any revised valuation on compliance with lending covenants.