A Bolt from the Blue: Upwards - only rent reviews to be outlawed

Introduction

Just as we were winding down for the summer, the commercial property industry was shocked by the announcement that the government has unexpectedly decided to seek to ban upwards only rent reviews (“UORR”).

The recently published Devolution and Community Empowerment Bill (the “Bill”) is vast with some 338 pages including 31 schedules.  The thirty-first schedule introduces a new Schedule 7A and 7B into the Landlord & Tenant Act 1954 (the "1954 Act"), which prohibit UORRs on future leases.  In this article, for ease, when we refer to ‘the Bill’ we are in fact referring to this schedule.

What does this mean in practice?

• All commercial leases granted after the coming into force of the Bill will be affected, (unless an agreement for lease was entered into before that date); it is not retrospective, however renewals of leases within the 1954 Act will be caught.
• Put options – where a tenant is obliged to enter into a lease at a future date - will also be banned.
• Fixed, stepped rents are not caught by the Bill, but open market, index-linked and turnover rents are caught.
• There are anti-avoidance provisions;
• Variable rent reviews can still be used, but reviews can go up as well as down.
• Rent “collars” – where the rent cannot go below a certain level – will not be effective.

Whose idea was this?

The Bill is sponsored by the Deputy PM, Angela Raynor, and the Minister of State for Local Government and English Devolution, Jim McMahon.  His view of the Bill’s effect is skewered to the supposed ills of the High Street, saying of UORRs that:       

“[they] pit landlords against businesses and can make rents unaffordable and cause shops to shut.  This will help keep small businesses running, boost local economies and help end the blight of vacant high streets and the unacceptable anti-social behaviour that comes with them.”

Framing the Bill as an uncontroversial measure to rejuvenate the high street is, in our view, disingenuous and ignores how other asset classes will be affected.  It also conveniently ignores the effect of high business rates on small businesses.    

The Bill in the context of the Law Commission Report on the Landlord & Tenant Act 1954

The Law Commissioners delivered their interim report in June.  It recommended so little change that we chose not to write about it.  Apart from extending the term of leases afforded protection under the 1954 Act from six months to two years, there were no headline changes.

The very conservatism of the approach, despite much commentary in the property press about how the 1954 Act has become unfit for purpose in the modern age, was itself a surprise.  The Commissioners said that this was because few participants in the consultation they had carried out had wanted a change.  As far as the commercial property world was concerned, everything was seemingly working well.

As an aside, it will be interesting to see what the consultees said when their responses are published later in the year.  Consultation responses are not anonymous, and it may be that many professional services firms did not want to alienate any of their clients by coming down on either side of the fence.

The Bill in historical context

UORRs were a product of the fevered property market after the second World War.  This was also the era when the 1954 Act was passed to curb what were perceived as landlord excesses in a climate of acute shortage of commercial property.

The recession of the nineties led to the first call to abolish UORRs, and there was a Department of the Environment consultation, which opted for a voluntary code rather than legislation. In fact, a private members Bill to abolish UORRs had been brought by a Conservative MP in 1993.

The first commercial lease code was introduced in 1995 by a working group drawn from the property industry and backed by the government.  The code aimed, in particular, to support small business tenants, by encouraging more balanced lease terms that better aligned with their operational needs.  Two further iterations followed, in 2002, and 2007.  The latest version was produced in 2020.

The self-regulation approach has received academic criticism for its lack of penetration.  There is very little awareness of the leasing code amongst the small businesses that are its target.  Anecdotally, we have found that it is mentioned, if at all, by solicitors acting for substantial tenants. Interestingly, the latest Code, issued in 2020, does not suggest that UORRs should be banned.  Instead, it emphasises the need for clarity in negotiating rent review clauses by tenants, and the importance of getting specialist advice.

In addition, the market itself has adjusted with shortening of leases representing a major structural shift in the commercial property market. Rarely these days will occupiers sign-up for 25-year leases unless they are entering into very large lettings or acquiring premises requiring a high level of capex to be expended in fitting-out works. UORRs are becoming less of an issue, because shorter lease terms and break clauses are now market standard.

Diversity our strength?

The government’s proposal lacks nuance - it is as simple as the high street is declining;  something must be done.  The government has already tried to do this with the largely unused ability for local authorities to auction unused high street properties mentioned below ,whilst ignoring the fact that high business rates are actually one of the main issues for high street businesses.

Even if it were to be conceded that small businesses trapped in overrented premises by rapacious landlords were part of the problem (it isn’t – see below), then why interfere in other efficiently functioning asset classes such as premium offices or warehouses?  Institutional investors, both domestic and overseas, are drawn to our robust commercial property system.  Rental yields are important for investors, and if the government bans UORRs, enabling rents to go down, that will affect property prices in the market, and if confidence is eroded and investors go elsewhere, this will have a negative effect on the economy.

Comparison with other countries

UORRs are unique to England and Wales.The Republic of Ireland abolished them in 2010.  We spoke to Hilda Rixon, Head of Commercial Property at Matheson's in Dublin, who said that:

"the market and lease provisions have adapted. Lease terms have shortened, and other rent review mechanisms have emerged such as index linked reviews, “cap and collar” clauses, and stepped rents.  Some of the pre-2010 leases still exist and when these premises come on the market the upwards only rent review is certainly seen as an attractive feature. However, these leases often relate to older premises and may not have the green credentials as newer properties."

European countries tend to have index-linked rent increases – which are also outlawed by the Bill, but with no explanation as to why.  Anglophone countries, such as Australia, have a mixture of index-linked and market-based provisions.    

The High Street

In the private member’s bill in1993 to abolish UORRs, the supporters of the abolition were already lamenting the death of the high street.  They gave examples of their constituency tenants trapped in long, overrented leases driven to bankruptcy and despair. 

In an attempt to tackle the ‘crisis’ Part 10 of the Levelling‑Up and Regeneration Act 2023, brought in compulsory auctions of unrented high street premises, based on the unsubstantiated assumption that landlords were refusing to let out their vacant premises and should be compelled to.  We have been unable to find any auctions that have yet resulted in successful lettings.

But will it happen?

In past articles, in the context of the Renters’ Rights Bill, we have said that with the government majority, any opposition amendment to a Bill will be struck down.  

However institutional investors are unlikely to sit on their hands in response to this threat.  They were successful with derailing Mr Gove’s plans to reduce residential ground rents to a peppercorn - HM Treasury pulled the plug on this reform, having been told of the detrimental effect on pension funds and insurers.  It is quite possible that this will happen again, and fiscal reality will trump political idealism.

Final thoughts

The very stealth of the Bill is worrying.  There has been no public debate on UORRs, such as we saw in previous years.  It is fair to say that that the Bill has not been well received by the industry in general.

The government’s impact assessment of the Bill is unnuanced, weak on data and analysis, and has appears to give no thought to any classes of commercial property other than ‘the High Street’.  The Regulatory Policy Committee response, dated 18 June, gave the Impact Assessment the green light, without any consideration of the data and analysis provided.

If the Bill proceeds, there will be unwelcome consequences, not just for landlords but potentially for tenants.  To preserve rental yields, landlords (or their lenders) may decide that fixed rental increases are required , which could well lead to overrented properties in the future.

We will be keeping you up to date with the Bill’s progress when Parliament returns in the Autumn.