Overall, which gives better net returns and security: Market Value reviews OR Indexation?

344 Streatham High Road, London SW16 6HH is a ground-floor shop, half used as a hairdresser and half sub-let as a pavement cafe. The rent with effect from 19 May 2016 was £30,000 p.a. A Market Value rent review set for 19 May 2021 went to Arbitration.

The tenant submitted a Calderbank offer of £35,000 p.a. My valuation was £40,000 p.a. and the landlord Calderbanked at £38,000 p.a. The tenant’s submission to the Arbitrator was a Market Value of £26,000 p.a. but accepted it was an upwards-only rent review. The Arbitrator’s Award was £32,000 p.a. issued in February 2023 (1.75 years after the review date).

RICS appointment fee just under	£500
Landlord’s valuation fee	£2,400
Landlord’s arbitration costs	£3,960
Tenant’s adverse costs	£4,800
Arbitrator’s fees	£8,100
TOTAL	£19,760
Aggregate rent increase over next 5 years	£10,000

It is accepted that the institutional, large and prime property landlords will almost certainly stick with market value reviews. The sums of money involved justify that. What is suggested is more for the small private investor, investing in neighbourhood or convenience premises often let to small businesses.

The nature of suburban retail trade has changed dramatically. Much has migrated to on-line, retail parks, home delivery and similar methods of purchase. Many pure retailers have been replaced by service traders, cafes, restaurants, personal care and quasi office uses. Class E for Town and Country Planning purposes has allowed this change to sweep in and change the face of many local shopping streets. Some of these trades pay better rents and spend more on improvements. Many retailers want 5-year break clauses because of the uncertainty over rent increases and declining retail trade. Many of these other businesses want long-term security to justify the cost of the improvements, equipment and trade establishment.

Landlords want long-term security of income. Both landlords and tenants want relief from the sometimes ridiculous cost of negotiating market rent reviews with unpredictable results. Landlords do not want the risks of vacant properties at short intervals. Tenants do not want the risks of severe rent shocks every 5 years or having to move their business as a consequence.

At 10 Western Parade, Barnet, a retail sushi bar vacated recently: the business owners retired and returned to Japan. A care recruitment agency is taking a new lease for 10 years – no break clauses. To avoid the risk of an unpredictable and possibly uncomfortable 5-year rent increase, market rent reviews are out. Annual RPI adjustments have been agreed. Over the years we have noted that a new letting at a “premium” rent is often followed by a small or disappointing first review to market value, but with disproportionately high professional fee costs for the exercise of agreeing floor areas, comparables, comparison and specific lease term adjustments, negotiation strengths and weaknesses, application for third party appointment, and so it goes on. Nor is there much job satisfaction in charging a fee for little or no added value.

At an industrial site in Stevenage, immediately adjoining an electricity substation, a new letting was agreed to an electricity generating company which installed 5 large gas-fired turbines, which can be turned on and off at short notice whenever the National Grid is short of capacity and might otherwise have to impose a blackout. The tenant has a supply contract at a base price per KWh with annual CPI indexation. The turbines have an expected life of 21 years. How to assess market rent on reviews? Comparables? Professional fee costs? A 21-year lease with annual CPI indexation to mirror their income contract was agreed with effect from November 2019. The cumulative increases to November 2022 have been 16.77%. It is owned by a consortium of private investors in a small FCA regulated fund we manage. The investors are happy.

There are short term businesses like firework shops which can come, unpack, pack up and leave at short notice. There are retailers who buy stock in, sell stock out and moving elsewhere is not that difficult. There are restaurants, dry cleaners, dentists and others who have expensive capital equipment to install, often on long term contracts, who cannot just pack up and move on. There are destination businesses which need a long term known address where customers know they can find them. The newish Class E is bringing a much wider range of businesses to what we used to call neighbourhood shops, especially as offices are being converted to residential and some small businesses are trying to find somewhere other than their home from which to operate.

Colliers International published research paper: in 2020 Colliers published this research entitled:

Rent reviews: RPI vs Open Market?

Hindsight is a wonderful thing! Generally, for industrial properties, which is what they researched, the RPI reviews were better for landlords but caution is required. There are proposed changes to RPI probably coming in in 2030 which will align it closer to CPI (approximately 8% difference).

Critically, the Colliers’ paper does not take into account the cost of settling rent reviews to market value compared with the cost of indexation.

Caps and Collars: some parties are nervous about RPI and insist on a cap and collar. Typically, the cap is no more than 4% p.a. and the collar is no less than 2% p.a. Therefore, for a review at a 5-year interval we are talking about somewhere between 10% and 20% increase depending on how close to the 2% inflation target RPI can be maintained.

Although there are some rents which do leap ahead more than that on a market review basis, there are also some rents which show very little growth over a 5-year period. On balance, it seems to me that the long-term investor who is looking for long-term security of income rather than a speculative increase and profit would be very happy with initial rate of return plus those sort of increases over a 5-year period.

RPI Review Clauses: one of the problems which is sometimes canvassed is not knowing where to find an RPI review clause which can be easily operated by an ordinary businessman and does not require a high quality maths degree to resolve with the risk of an argument over correct interpretation.

If you Google up RPI rent review clauses you will find plenty of samples available and I attach the form which I now use on local neighbourhood shops where RPI increases can be agreed.

Renewal at the end of the term: in the case of HPUT Trustee –v- Boots in the Central London County Court (G00CL673, Judgment date May 2021) there had been sale and lease-backs of Boots Stores in 2005 in which the agreed rents were increased by a fixed amount of 1.5% p.a. The leases expired in 2020. The landlords were looking for new leases with stepped increases; the tenants were looking for leases without stepped increases.

It is instructive to read the decision (it is long and pretty boring from the point of view that many of the matters considered rarely come up for discussion!) but a lot turned on what Section 34 of the Landlord and Tenant Act 1954 allows the Court to consider by way of rent and reviews/increases.

Just to give you a flavour of the way the case went, I would quote Paragraph 98, but do not rely on this to the exclusion of other aspects of the decision:

…having regard to the evidence that I have seen, there is no market for a stepped annual rent increase. In any event, even if one were to consider the request for such a provision under section 34(3), there is no market evidence of such a rent increase provision. Further, the experts seem to agree, that it would be a highly unusual provision to find in the market.

The 1954 Act is driven towards market evidence, not to stepped increases or indexation. However, regard is to be had to the terms of the old lease, although that does not bind the Court with regard to the terms of the new lease.