Leases, Landlords, Location Location - Demystifying Rent Reviews for Retail Tenants

Navigating Commercial Rent Reviews: Key Strategies and Considerations

In this episode, host Gary Marshall delves into the intricacies of retailer rent reviews, emphasising the importance of understanding and reading the lease in detail. The episode outlines two main aspects of negotiating rent reviews: the physical survey and reading the lease. The discussion covers critical points like the frequency of rent reviews, potential stipulations in leases, the impact of neighboring tenants' settlements, and the importance of obtaining expert advice. The host also explores potential pitfalls in rent reviews, such as the landlord's right to value tenant improvements and the concept of a hypothetical lease. The episode concludes with advice on handling disputed rent reviews, including the arbitration process and the importance of having documented agreements.

00:01 Introduction to Rent Reviews

00:34 The Physical Survey and Lease Reading

01:32 Key Considerations for Rent Reviews

02:37 Understanding Rent Review Clauses

03:41 Collaborating with Neighboring Tenants

04:47 Hypothetical Valuations and Assumptions

06:31 Economic Climate and Rent Reviews

08:35 Disputed Rent Reviews and Arbitration

12:19 Valuation Principles and Comparables

15:54 Final Thoughts on Rent Reviews
 
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Transcript

0:00

In another episode, we talked about reading the lease, RTL, because a lease is the sum of its parts and that sum points towards its value. Now this is never more true than a rent review. Rent reviews are close to my heart. I started in retail estate management back in the 1980s, and I often negotiated rent reviews for the occupying tenants. Of course. In locations up and down the country. I occasionally find myself in a town that I haven't visited for a long while and find myself drawn to go find that old next Woolworth Sketchly Pizza Hut. Although of course, in most cases it's now a coffee shop or some other well-known brand. There are of course two aspects to negotiating a rent review. One is the physical survey, measuring up, establishing the usable areas, noting the less usable ones, and then searching for comparable evidence often by asking the estate manager of the adjoining premises for a breakdown of their most recent transaction or settlement. Mutual back scratching, pay dividends. The other aspect is in reading the lease to establish exactly what it is we will be valuing. In many cases, the contractual lease will dictate certain points, impose certain assumptions, stipulate various expectations, so that maybe the actual premises, bare little relationship to the hypothetical lease, which we have to assess. In this episode, we can discuss those assumptions and stipulations. We revisit the actual valuation side in another episode, but reading the lease is critical to not get caught out paying for something that isn't, in fact meant to be valued. So where to begin? Well, many commercial leases allow for rent views at certain periods through the term of the lease. Maybe in modern, shorter leases it's less common, but there are plenty of legacy longer leases still out there. Obviously rent reviews are a specialized and well litigated area for the experienced practitioner. Probably not for the fainthearted at all, first timer, but let's look at some of the topics, which must be considered when looking at a rent review on behalf of the tenant of the commercial property. Always remember the first rule, read the lease. Our acronym of RTFL is never truer than at this point. Don't get caught out by missing a time of the essence. Counter notice deadline. It is not uncommon for a poorly negotiated lease to contain a series of action points which carry deadlines. An example might be that the tenant has just a fixed number of weeks to respond in objection to a proposal in a notice by the landlord. So if the landlord craftily proposes to double the rent and the tenant fails to respond in a timely manner, guess what happens? And whose fault will it be to read the lease? The frequency of the rent review may also be relevant. We are aware of many commercial leases from the 1980s, 1990s. Granted for terms like 25 or more years with five yearly rent reviews, but this frequency isn't standard. There are many occasions where reviews are annual or irregular periods. It's important for the tenant's property guy to know this and to be able to forecast likely changes in rent payable as a result of these reviews. There is often a stipulation that the rent at review can go up but never down. This is known as a ratchet effect and it's designed to protect the landlord's income stream against falling market values. And if that sounds a little one-sided, always remember that nobody made the tenant sign the lease. Some rent reviews stipulate fixed values on given dates. Others might use a form of indexation, such as the increase in the retail price index on a specific date, and some are really formulaic like they were written by Einstein. Not at all easy to understand, but delivering a known answer. It's important in any consideration of a rent review to consult and liaise in fact, collude with neighboring tenants, many of whom might be facing the same rent review on the same rent review date against the same landlord. It could be useful to form a united front and to share resources and information. And of course it's important to be wary of a rogue settlement where one tenant might conclude their interview for reasons which might not be immediately apparent, but which then seems to create a high comparable for the landlord to cite against the remaining neighbors. I. And I keep saying neighbors because in this sense, rent reviews are often very parochial. Market values can change from town to town, retail part to retail, part street to street, one side of the street to the other. So the most salient evidence might be right next door carrying more weight as evidence of value. Than any transaction in another location and more on this valuation aspect in another episode. Certainly a skilled analysis of any settlement is essential. So get good experts advice from a property specialist in this sector and never take any unusual deal at face value. The lease may require the valuation to be based on assumptions of a hypothetical scenario rather than the actual details of the real life. Lease and premises, the hypothetical lease might be for a specified term of years, which may be more or less valuable in any comparable, and indeed might be at odds with the actuality of the lease being subject to review. Some leases stipulate that this hypothetical valuation should ignore the tenant's shop fittings or improvements in goodwill. It might assume vacant possession and might assume a willing tenant ready to take the lease. But be wary that a willing tenant isn't necessarily a stupid or a reckless tenant willing to pay above the odds at market price. In some situations, the landlord may attempt to value the tenant's own fixtures and fittings, treating them as if they were landlords, chattels, particularly if changes were made without landlord's permission. Tenants champions should always ensure that tenants don't end up izing improvements that they've already paid for. Imagine the difference in let ability in curb appeal in what a willing tenant might pay for a fully fitted out shop unit with air conditioning staff rooms, a mezzanine trading area, solar panels, LED lighting, you name it, compared to the empty shell that the landlord originally let to the tenant. If the lease doesn't allow the landlord to ize these F and f, make sure they're included, value the shell. There are lots of other clauses to consider. Maybe have another listen to that episode about reading the lease. Are there restrictions in the permitted use? Is there surplus space that can be assumed to be under lettered to profit? Is there anything which is personal to the actual tenant, therefore can't be ascribed to the hypothetical, alternative willing tenant in those weird assumptions. Of course, in the current economic climate, many rent reviews are at best a token activity because the rent already payable under the lease is notably higher than the provable market value for similar properties in the proximity. In cases like this, the landlord may choose not to even bother pursuing the rent review, particularly as they might have to pay their advisor even if there's no upside. They might choose to just ignore it, leave it open-ended. This can be challenging for some tenants who need more certainty in their financial planning. So in some cases, the tenant may insist on getting the rent review documented at the passing rent figure. These settlements are often referred to as nil uplift because the ratchety effect of the lease doesn't allow the rent to go down, but there is no evidence to support it going up. From the tenant's perspective, it is important to monitor rent reviews, which are not settled in a timely manner, especially in case a subsequent deal, even after a period of time has passed, might suddenly break a stagnant period with no growth and form a critical piece of evidence for a backdated rent review. Just because the date of the rent view is passed doesn't stop. Local values changing or stop landlords trying to demonstrate on a sliding scale that there has been an increase across some preceding years. If a tenant is concerned about outstanding rent reviews, they should of course plan for them. A forecast of estimated rental value, simply known as an ERV, should be realistic and should be supported by an independent valuation. Drafted by somebody with expertise in the sector. Guesses and fingers in the wind are reliably unreliable. RVs should be revised on a regular basis, maybe each year, maybe as part of a three year rolling plan in case values change as locations develop or degrade. Forward-looking RBS are a key component for the retail business to accurately manage the possible uplift of any reviews. No finance controller likes a nasty surprise when a big backdated settlement invoice comes in unexpectedly. I. And of course some reviews get settled quickly while others drag on and on. But when they are eventually settled, the tenant must be ready to pay up. The landlord is entitled to receive the backdated funds straight away and might even be able to charge interest on backdated rents as if they were arrears from years ago. And if that sounds one-sided and unfair, just remember nobody made the tenant sign the lease. Always read the lease to understand exactly what the landlord's rights are. And we like to think we're all good negotiators able to cut through the smoke and get to the point and agree the right deal. But life's not always like that. Some landlords, and in fact some tenants are just stubborn, some evidence could be dubious. Some lease terms could remain unclear. In the event of a dispute or the inability to reach a negotiated settlement, there is generally an opportunity for some form of arbitration. Again, read the lease. It will advise you whether the matter can be resolved by an arbitrator who must assess only the evidence submitted by the opposing factions or by an expert witness who can give their own view on value irrespective of any evidence provided. Best to know which type of resolution is required. Under the lease, it might clear judgment on whether to keep pushing forward or to tactically yield before wagering everything on a final spin of the wheel. Another reason to avoid arbitration might be that it can be costly in terms of getting expert advice and professional support and maybe paying the other side's fees. And if the landlord is insistent on taking it forward, perhaps using this as a form of pressure test on the tenant's willpower, it might be advisable to anticipate a claim to recover those costs. The arbitrator might be in a position to give two determinations, one on value and the other on costs. So it isn't unusual for either the landlord or the tenant to submit what's known as a Calder bank offer, which is made without prejudice to the actual settlement or arbitration process, but can be produced later as an indication that the other party's case was perhaps vexatious and incurred costs that shouldn't have been necessary. And a rent review, of course, is only as good as the paper is written on. Verbal agreements are generally not as reliable as a signed contract. It's usually sufficient to sign a brief rent review memorandum stating the date of the review, the date it was agreed, and the new value, whether uplifted or not. These documents might be signed by an authorized signatory on behalf of either party. They don't generally need the actual landlord to press their wax seal onto costly parchment, but bear in mind, in some cases of arbitration, the arbitrator's award is actually binding as the document of the new rent, even though it's not signed by either landlord or tenant. And it would stand up in court as evidence that the rent review process was followed and a value was determined. So from the date of the award, the new rent becomes payable. And so to the nitty gritty of disputed rent reviews and the common practice in most retail leases, that these will be resolved by a referral to a third party, possibly nominated by the RICS, the Chartered Surveyors organization. And as I mentioned earlier, an arbitrator can only consider a range of evidence put forward in submissions by the valuers acting for the tenant and the landlord. Whereas by contrast, an independent expert may be happy to receive submissions, but at the end of the day, the expert will make up their own mind whether there is evidence to support it or not. And in most leases, the third party's decision is final and binding on both sides. Evidence to prove a value is a complex and curious thing. Many values who specialize in this field refer to these as comparables, meaning that they gather information on deals that have been done, whether open market lettings or negotiated deals at rent review or lease renewal, and then try to make allowances for how closely the comparable property actually compares to the subject property aspects that can make a difference include. Location, location, location on the premise, the, the better the location, the higher the rent per square foot. So if a subject property is in a far inferior location to the comparable property, it suggests that the rent should be well inferior. Also, physical configuration. A building formed of a single, spacious retail space, 10 meters wide by 20 meters deep, is much easier to use as a shop. Then a higgledy piggeldy arrangement of small rooms on various levels with rickety staircases. So the spacious retail space will probably command a higher rent per square foot. I say probably, maybe, possibly, maybe not at all. If other circumstances apply, the permitted use of a comparable might also have a bearing. Traditionally deals on buildings where the lease terms allowed a rare or unusual use. Maybe an estate agent's office or a restaurant might carry a higher rent per square foot than a standard retail store. So the tenant's valuer, negotiating on a lease where the use is less exotic, might argue a discount. But in the modern valuer's opinion, maybe today, an estate agent's office is less valuable than it once was. I mean, they've all gone online with right move, right? Who needs a high street window? And rare uses like a bank. Once upon a time, this was considered a premium use with a premium higher than average rent. But as banks across the nation have more recently closed all their high street branches, who's to say that a bank or financial office still carries a premium value? Maybe bank use is now a millstone dragging rental value down when compared to a nice, open, easy retail shop. But just when you thought the valuation principle was clarified, we also have to consider those darned assumptions that we mentioned earlier. The diligent tenant or their valuer who has read the lease might notice an inconsistency. Hang on a moment. My actual user clause restricts me to only a retail shop for clothing. But the assumptions in this rent review clause say the valuation can assume the higher of retail, office, bank, leisure, dining, restaurant. Hang on a minute. Who signed this lease? So beware when signing a new lease that the proposed rent review assumptions don't include any use that might give the landlord a higher value than the actual lease. Use allows and beware when negotiating a rent review on an existing lease that the assumptions that were signed up to won't impact you. But of course, they are unavoidable because they're embedded in the lease. The best strategy is to liaise with a property specialist with experience in this area who can expertly navigate the best course to achieving the lowest possible increase, or even a reduction for a lease renewal, or one of those rare rent reviews that isn't upward only. So there we have it, a brief journey through some of the points to consider when approaching a rent review. Tread carefully and be prepared, and most importantly, read the lease. I.