How new law could affect rent reviews

Jan 12 2005 By Richard-Freeman Wallace, The Journal

The year 2005 is likely to see one of the most important pieces of property legislation come into force, which would transform the way in which landlords set rent reviews.

The Office of the Deputy Prime Minister published its `consultation paper' on upwards-only rent review (UORR) clauses in 2004. It was issued before the release of Reading University's final findings into the impact on the property industry of the Code of Practice for Commercial Leases. That may suggest the Government has already made up its mind on the principle of legislative change to the rent review process.

The university's interim report "shows that UORRs are still virtually the only form of rent review". It states that: "The Government is therefore now consulting on options to deter or prohibit inflexible leasing practices, focusing on use of UORR clauses". Six options are set out. They are:

* Do nothing: This will occur only if the voluntary code has a `significant impact in encouraging more leasing flexibility' by year-end.

* Ban upward-only rent review clauses.

* Ban, subject to a floor of the initial rent.

* Give tenants a right to break if the UORR produces a rent above open market levels.

* Establish a statutory maximum lease length for commercial lettings.

* Require landlords to give tenants priced options.

The report says `legislative action would be justified if voluntary measures were found not to be promoting greater fairness or efficiency in the property market or if the Government found they didn't satisfactorily address market imperfections'.

The view of the property industry appears to be that the Government should avoid legislation. If introduced, it will benefit larger organisations that have taken professional advice. It may well not help smaller traders who may end up paying higher rents to compensate landlords for the possibility of rent going down.

If legislation is introduced to ban UORRs it will probably lead to pressure to abolish the Landlord and Tenant Act 1954 which provides protection to occupiers. The institutional investor at one time had a 25-year lease with five yearly reviews and it was standard for landlords to insist on the rent review being upwards only.

The investors' argument is that this provides a stable basis for investment benefiting economy and business. But tenants are fixed with a rent that bears no relation to the market and argue it's unfair to be fixed with rents at an inflated level.

Some objections to upwards-only rent reviews have lost force as leases became shorter.

But the argument remains that the market is skewed too much in favour of landlords. While in theory a letting is a function of the property market, tenants in reality have no choice but to accept upwards-only rent reviews. Tenants argue legislation is required to level the playing field.

The Government must be careful of the effect legislation will have on investment and regeneration of depressed areas. If it concludes Reading's report indicates landlords still use UORR without offering tenants a genuine, informed choice of alternatives, it will consider statutory control. But if Reading's report indicates either that tenants receive an appropriate choice or that use of UORRs in longer leases has significantly declined, the Government will do nothing.

Of the major law changes in the last year, this could be the most significant for the property industry. We will have to wait to see how many if any of the options outlined are realised.

Richard Freeman-Wallace is head of property at Watson Burton LLP