Banning Upwards-only Rent Reviews – An International Perspective

In the UK, a ban on upwards-only rent reviews was first contemplated in the 1990s. Since then, the landlord and tenant relationship, particularly in high street retail premises which are understood to be the focus of these provisions, has been transformed. In the context of the decline of many shopping districts, high street retail leases are now significantly shorter, and tenants often benefit from a range of incentives such as lengthy rent-free periods, break rights, and capital contributions to their fit-outs. It could therefore be argued that this is a solution looking for a problem to fix.

The proposed legislation is also a blunt tool. Rather than being limited in its application to retail units, it will apply to all business tenancies including offices, retail parks, industrial and logistics units, hospitality and leisure facilities, and healthcare premises such as GP surgeries.

Investors are concerned about the additional uncertainty around income and funding structures. Investors such as pension funds have been drawn to real estate in order to benefit from long term, inflation linked income, which may be threatened if rents will henceforth be able to fall as well as rise. However, it is possible that such investors may be able to adapt to stepped rent increases which are permitted under the draft legislation.

These provisions may also change lenders' appetite for commercial rent estate in the UK, which would impact on the cost and availability of funding for development, contrary to the Government's stated aim of trying to stimulate economic growth.

For business tenants, although they may be able to benefit from rents which could fall as well as rise, or are instead fixed at predetermined increases, it is likely that landlords will include more landlord break options, higher initial rents, and fewer incentives such as capital contributions. This will not help the small businesses with weaker covenant strength who need support from Government, landlords and the wider economy.

Sarah Walker, Partner, Travers Smith LLP

As a direct reaction to the global financial crash in 2009/2010, and in an effort to help struggling retail tenants in particular, Ireland abolished upwards only rent review provisions in business leases entered into after 1 March 2010.

As the legislation could not be applied retrospectively, its introduction initially had the opposite effect to that intended. It immediately created a two-tier market where tenants on 'new' leases were able to avail themselves of significantly lower rents due to the economic crash and those tenants also got the benefit of open market rent reviews, whereas tenants on 'old' leases were tied to rents set at the height of the market and to upwards only provisions for three or four more rent review cycles. The position of tenants on 'old' leases was not helped by the fact that the average lease duration at that time was 20/25 years, sometimes with a 15 year break, but not always.

Instead of alleviating the pressure on struggling retailers, it made it worse. Tenants with leases predating the legislation could only escape their onerous rent obligations if they had a break clause, which was rare, or, more commonly, were forced to close down because they couldn't afford rents far above market rate. Meanwhile, new tenants often paid up to 50% less for comparable spaces, putting longstanding businesses at a significant disadvantage.

In the immediate aftermath of the introduction of the legislation, there was an assumption that alternative rent review mechanisms would be used to give landlords certainty on return, including

• stepped rents
• fixed rents
• CPI rent reviews
• rent reviews subject to "cap and collar" adjustments.

Other than CPI reviews, these alternative approaches did not achieve broad usage and remain relatively uncommon.

Landlords also tried to introduce rent review clauses that could only be triggered by the landlord, since the Irish legislation didn't explicitly address this. Unlike the draft UK legislation, which propose clear anti-avoidance measures to make landlord only triggers unenforceable, it's still uncertain in Ireland whether such clauses would stand up in court as the wording of the Irish law bans any condition that effectively operates as an upwards only clause.

One notable effect of the legislative change, however, was a shortening of typical lease duration in Ireland. At the time the law was enacted, leases commonly lasted 25 years and often included no option for early termination. Today, retail leases typically span five to ten years. Office and logistics leases, where currently there is significant development investment in Ireland, still tend towards fifteen-year fixed terms with open market reviews so that developers have some certainly on investment return.

Over the last fifteen years, Ireland's shift to open market rent reviews has become widely accepted, with the broader property sector ultimately embracing this model as the norm.

Many of the impacts of the abolition of upwards only rent reviews were softened because the market was at a historically low point in 2010, so rents have generally been increasing as the market has steadily recovered. However, it remains to be seen how it will respond to any future downturn.

Brian O'Callaghan, Partner, William Fry LLP

In the United States, most commercial leases typically use fixed base rent throughout the initial lease term, with any increases being pre-agreed (such as annual CPI adjustments or fixed percentage bumps) rather than periodic market-based reviews. When leases include renewal options, these generally fall into two categories: (1) pre-negotiated percentage increases (such as 2-3% annually or CPI adjustment), or (2) fair market value resets determined through appraisal or arbitration processes with a floor being the previous rent (or some agreed upon percentage increase in the previous rent).

The UK's proposed ban targets "upwards-only" rent reviews (i.e., clauses that prevent rent from being reduced when a lease is reviewed or renewed). If similar legislation were enacted in the US, it would primarily impact renewal clauses using "greater of" formulations as noted in clause (2) above. However, we suspect such a ban might actually lead landlords to cease giving tenants the benefit of renewal options or abandon market-based rent renewals entirely in favour of predetermined fixed increases, since they would no longer have downside protection in declining markets.

David J. Rabinowitz, Director, and John Rothman, Counsel, Goulston & Storrs PC

In Australia, retail leases are governed by similar legislation to the Bill's proposals, but on a state by state basis. Retail leases extend beyond shops to commercial premises used for the provision of retail goods and services. This is consumer protection legislation designed to protect smaller tenants. Each state is a little different but they are broadly similar in principle. If the retail leases legislation does not apply, in most cases, there is no restriction on the type of rent review that may occur in Australia.

Where a tenant has the protection of retail leases legislation, market reviews are allowed during the term or option periods of a lease but there are specific requirements in place for market reviews –rent can go up or down and specific inclusions and exclusions are mandated. In practice, a mid-term market review is rare except for very long-term leases – they are typically only used for option terms.

As an example, in Victoria the Retail Leases Act 2003 applies to premises leased wholly or predominantly for the retail provision of goods or services. Retail is defined broadly and includes business providing retail services or goods to other businesses – eg professional services, offices (which are not back of house), cold storage facilities etc. There are exemptions for certain leases – key ones include where occupancy costs exceed AUD$1,000,000 per annum as well as public companies (domestic and foreign) and their subsidiaries. The Act allows rent reviews to be conducted using only one of the following five methods:

1. Fixed Percentage Increase – e.g., 3% annually.
2. Indexed Review – typically linked to the Consumer Price Index (CPI).
3. Fixed Dollar or Percentage Amount – e.g., $50,000 or 3.5% increase per year.
4. Current Market Rent – determined by valuation using the method set out in the Act – see below.
5. Prescribed Formula – though none have been prescribed to date.

Mixed methods (e.g., CPI + market rent) are not permitted under the Act. However, different methods can be used in different years, as long as only one method applies at any given time. Importantly in the case of market reviews, clauses that prevent rent from decreasing after a review are void – ie no ratchet clauses. A further similarity is that if the landlord fails to initiate the review within 90 days, the tenant may initiate it.

Australian retail leasing legislation has been in place for over 20 years. It has resulted in a reduction in the use of market reviews and landlords offering option terms, particularly for shop leases. The long-held position and market practice that has developed for retail tenants has not, in practice, flowed through to larger tenants not covered by retail leases legislation, and there would be significant push back if such a change were proposed.

Nathaniel Popelianski, Partner, Head of Real Estate, Corrs Chambers Westgarth

It is clear, not only from the legislative process in the UK, but also from the views summarised above, that the English Devolution and Community Empowerment Bill has a long way to go and could be significantly re-shaped during its passage through Parliament. For now, the Bill appears to be wide ranging and seeks to cover all bases. It will certainly be interesting to see whether industry pressure persuades the Government to reign back some of its provisions (and perhaps the Government was always mindful of this likely outcome).

As a property litigator working through the COVID 19 period, and having experience of running related arguments up to the Court of Appeal, it is difficult not to consider the impact such extraordinary events could have on a rent review. If the Bill had been in place during that period and a rent review date had fallen on 24 March 2020 (one day into lockdown) how would this have played out? In my view, it was the certainty of ongoing rental income, with the compromises reached between the parties, which allowed the real estate market to survive such times. Therefore, an unlimited upward and downward review appears unlikely to feature in a re-shaped real estate market after implementation of the Bill.

It is also clear that the Bill will give a wide scope for potential litigation and for the creation of avoidance schemes by sharper minds than this writer. There are current gaps in the legislation, such as considering intermediate landlords, and the need to promote certainty in the market that will also need to be worked through.

In any event, it is clear that the Bill could rewrite how landlords and tenants approach negotiations. Flipping that one-way street into something more flexible feels like a bold legislative nudge toward fairness for tenants, though it will clearly ignite thorny disputes over valuation mechanics and lease drafting.