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Rent review update
Rent review update
In rent review terms, 2004 has been dominated by something that might happen and by something that ought not to have happened. Consequently, this article focuses on the prospect of legislation to reflect the government’s disdain for upward only rent reviews and on the startling impact on rent reviews of the latest tranche of disability discrimination law.
Upward only rent reviews
The commercial property industry has been on notice that the government intends to legislate on a range of issues relating to leases. The Government’s objective is to impose flexibility upon the commercial property market, and to protect tenants from the perceived iniquity of upward only rent reviews.
In May 2004 the Office of the Deputy Prime Minister (ODPM) issued a consultation paper setting out six “options for deterring or outlawing the use of upward only rent reviews”. Of those six options one (“do nothing”) was dismissed within the consultation paper itself. That left the following five options:
Ban UORR clauses: primary legislation would be used to ensure that any rent review clause would operate as an either-way clause and to override any provision that denied the tenant the right to initiate the review. Existing leases would not be affected, so, for a time, there would be a two-tier market. The Landlord and Tenant Act 1954 would have to be amended in respect of lease terms on renewal.
Ban UORR clauses subject to a floor of the initial rent: this would require similar legislation. It would clearly have little material impact in the case of a ten-year term with five-year reviews. All reviews would be either way, subject to this floor.
Give tenants a break right if the UORR were to produce a rent above open market levels: this is an escape route that tenants sometimes negotiate now. Again, primary legislation would be required. Disputes could arise as to whether the new rent was above open market levels.
Limit lease lengths: this would involve primary legislation imposing a statutory maximum length of lease for commercial premises. It would amount to a radical intervention in the working of the property market, as was acknowledged by the paper.
Require landlords to give tenants priced options: in theory, this would give landlords and tenants what the ODPM believes they want. It would be difficult to police and enforce, particularly as the requirement would arise at the pre-contract stage.
There is much to criticise in each of these options for change. However, the fundamental objection to all but the last is that they seek to achieve flexibility by imposing legislative restriction. Each option – including the last – represents a significant attack on freedom of contract and has the potential to create distortion rather than flexibility.
Both the British Property Federation (which opposes legislation) and the British Retail Consortium (which supports an outright ban of UORR clauses) rejected the proposal to limit lease lengths, pointing out that any such limit would both damage the landlord’s investment and impair the tenant’s ability to recover capital investment. The British Retail Consortium also considered that imposing a requirement for priced alternatives would be difficult to implement and extremely difficult to monitor given that the offering of such alternatives will take place before heads of terms and so the range of alternatives and the tenant’s informed rejection of all but the final deal is unlikely to be documented in any readily retrievable manner.
The British Retail Consortium’s criticism of a requirement for priced options in fact reflects the fallacy that lies at the heart of the government’s approach to the question of flexibility: that it must either flow directly from the Code for Commercial Leases or be imposed by legislation.
The official view emanating from the ODPM is that any decision to legislate will follow the results of the interim evaluation of the voluntary Code for Commercial Leases being undertaken by Reading University.
The second edition of the Code was published in April 2002. It followed a report on the first edition in which Reading University concluded that whilst greater flexibility had become evident in the market since 1995 it was not possible to show a direct causal connection between the Code and that increased flexibility.
This time around the problem remains. Unless a causal connection can be shown the government may well announce that the Code has “failed”. The narrow remit given to (and apparently accepted by) Reading University means that the odds are heavily stacked against any finding that the Code has “worked”. In the context of government statements to date, this could well mean that where voluntary self-regulation is held to have “failed”, legislative compulsion would be considered necessary.
In essence, the government’s proposals would seek to impose a simple “solution” upon a complex situation. The commercial property market is both complex and diverse. It is also increasingly flexible. At the end of September, the seventh edition of the BPF/Investment Property Databank Annual Lease Review was published. This review provides detailed evidence of around 87,000 tenancies (including 8,700 new leases granted in 2003/2004).
The headline data states that shorter leases have become more frequent, with approximately two-thirds of leases granted in 2003/2004 being for five years or less. Small to medium-sized enterprises (SMEs) have an average lease length of five years, with more than 90 per cent of leases granted to SMEs being for ten years or less. The effective term of leases that contain break clauses is a mere 4.6 years; 40 per cent of leases of less than six to ten years (from start to expiry) contain a break clause. The research demonstrates that the property market carries out its own adjustments and that lease terms are freely negotiable. Yet in the face of demonstrable flexibility, the threat of interference in the marketplace remains.
At root, the difficulty is one of evidence. The key recommendation of the Code is that landlords should offer price adjusted alternatives, with a higher initial rent being the most likely price for an upward or downward rent review. Faced with a range of priced alternatives – and with initial cashflow constraints to consider – it is quite likely that a new tenant would opt for an upward only rent review in return for a lower starting rent. Yet unless that decision has been recorded and made retrievable there is nothing to rebut an assertion that the landlord has imposed an upward only review on a vulnerable tenant.
The risk to the commercial property industry – and ultimately to the Treasury – is that legislative interference will militate against the flexibility and sophistication that characterises the letting of property in this jurisdiction. It is highly unlikely – given the academic rigour with which Reading University undertakes its tasks – that the Code can be shown unequivocally to have “worked”. Yet to infer from that a failure in the market to adjust – and to use that inference to justify interference – would be extremely unfortunate.
Disability discrimination – can premises be “compliant”?
Significant new duties for service providers under the Disability Discrimination Act 1995 (the DDA) were introduced on 1 October 2004. They arise where physical features of premises make access to the services provided on or from those premises impossible or unreasonably difficult for disabled people.
The DDA affects anyone who provides goods, facilities or services to members of the public, whether paid or free. Except where health and safety regulations would be breached, it is against the law to refuse to serve a disabled person or to offer them a service which is inferior to that offered to others, or offered on different terms.
For the purposes of the DDA “disability” means a physical or mental impairment having a substantial or long-term adverse effect on ability to carry out normal day to day activities. Disability covers an extremely wide range of physical and mental incapacity, including impaired sight or hearing and learning difficulties. Only 5 per cent of disabled people are wheelchair users.
Much of the press comment on the new duties has assumed that compliance will require significant works to premises. In a recent seminar a leading surveyor asserted that DDA adaptation works would cost an average of £20,000, with the total bill running to £1.1bn.
It is tempting to assume that the owners or occupiers of premises must “do something” in order to comply with the new duties, and that the “something” in question must be alterations to premises. However, this is not necessarily the case. Those responsible for premises should bear in mind that these duties stem from legislation that is concerned with discrimination. They are not primarily property-driven, and there may well be many alternative – and far cheaper – ways to comply.
Service providers are required to do what is “reasonable” to comply with the new duties. The factors to be taken into account when considering whether an adjustment is “reasonable” are:
effectuality and practicality of the adjustment;
financial and other costs;
the extent of the service provider’s resources;
the availability of financial and other assistance;
any resources already spent; and
accessibility audit report.
The onus is upon the service provider to show that they have taken reasonable steps within their own financial constraints and other applicable limitations. For example, where the Church of England is concerned any work done to the church building, including the installation of induction loops, cannot be carried out until a faculty is granted. Some work, such as the installation of ramps or toilets will also be subject to secular controls in the form of planning permission and/or building regulations.
If it can be shown that services of the type provided on or from the premises can reasonably be provided in another way, then the assumption that works to the premises will be required may be questioned.
Consider, for example:
alternative venues for meetings; and
assistance with access to premises by designated helpers.
The key to DDA compliance is the service provider’s accessibility audit. Since the audit will be concerned with providing equal access to local people, the audit should ideally be carried out in conjunction with local disabled people. It should aim to identify the areas that need attention in the short term (where auxiliary aids can be used) and in the long term (involving physical changes to the fabric of the building).
It is important to remember that whilst the DDA duty is prompted by physical features of premises, discharge of that duty will not necessarily mean adjustment to those premises. The question is whether services can be provided in a non-discriminatory way. The duty is ongoing, and so it cannot be assumed that the findings of an accessibility audit carried out now will be valid next year. Regular reviews of access, and regular discussion with local disabled people will ensure that equal access is provided at all times.
So how does this relate to rent reviews? Discounts of up to 25 per cent have been awarded at review to reflect the view that the hypothetical tenant would be required to incur expenditure to make the premises “compliant”. In the slightly more reasoned version of this approach it was considered that there was a window of opportunity for tenants whose rent reviews occurred before 1 October 2004 when the new rules came into force. On that view, where a review occurred after 1 October there would be an assumption of compliance with statute and so no direct argument in favour of a discount (although there is an indirect argument that the assumption would be “onerous”).
The difficulty with this approach to rent review is that there is, in fact, no such thing as “DDA compliant” premises. The legislation looks to the provision of services, not to the state of premises.
The key questions at rent review are:
The assumed state of the premises – should the valuer be directed to assume that the premises comply with statutory obligations? If so, would DDA duties fall within the scope of a direction that the valuer should assume compliance with statutory duties in respect of the premises?
Should works carried out by the tenant in order to comply with its statutory obligations be disregarded at review?
Are works carried out “pursuant to an obligation to the landlord”, particularly where there is a tenant covenant to comply with statutes relating to the premises?
Will adjustments carried out by the actual tenant be identical to those that would be required by the hypothetical tenant?
If it can be shown that services of the type provided on or from the premises can reasonably be provided in any other way, an assumption that substantial alterations would be required will be unfounded.
Further, it must be remembered that, in determining a rent review, the valuer is concerned not with the actual but with the hypothetical tenant. The needs of the hypothetical tenant will not necessarily be the same as those of the actual tenant. On one view, this may drive valuers to assume that in fitting-out the unit to suit their needs, the hypothetical tenant is more likely to encompass the full DDA requirements beyond October 2004, and so will engage in an expensive programme involving: installation of wheelchair ramps, widened doorways and permanent induction loop system; relocating light switches, door handles and shelves; provision of contrasting décor to assist the safe mobility of a visually impaired person; and providing tactile buttons in lifts plus a whole host of other physical adjustments. Clearly, any hypothetical tenant faced with this list of expenditure would be likely to adjust its rent bid downwards.
However, to assume the necessity of such a programme is to miss the point of the DDA. Any actual tenant taking premises would of course have to consider making physical adjustments and would have to conduct an access audit. Having done so, that tenant might well conclude that its services could be provided in a non-discriminatory way by means of changed policies or procedures, improved staff training or by adopting alternative means of service provision. The cost of making physical adjustments could therefore be far less than initial estimates might suggest. If an actual tenant is likely to go through that process, it should be assumed that a hypothetical tenant would do likewise. So the impact upon the hypothetical tenant’s rent bid may well be minimal.
Difficult issues arise where an actual tenant has carried out substantial works to premises in the belief that such works were necessary to comply with its obligations under the DDA. If those works were not disregarded, the valuer might conclude that the hypothetical tenant, freed from the necessity of incurring expense on such works, would put in a higher bid than would otherwise be the case. There is a risk that the normal disregard of tenant’s improvements would not apply if a valuer considered that DDA duties were caught by the tenant’s covenant to comply with statutes in respect of the premises. On that argument, works to comply with the DDA would be carried out pursuant to an obligation to the landlord and so would fall outside that disregard. Their value could then be rentalised.
An assumption that there is such a thing as DDA-compliant premises could well lead to subjective assessments about DDA compliance that would, in effect, override the conclusions actually reached following an access audit. Whether the result is an uplift or a discount, it could well be unfair and might be open to challenge on the basis that the valuer had exceeded his contractual remit. The issue must therefore be approached with caution.
Malcolm DowdenCharles Russell Solicitors