The English Devolution and Community Empowerment Bill (the Bill) was introduced to Parliament on 10 July for its first reading in the House of Commons. The Bill, as the name suggests, is mostly concerned with increasing devolution. However, there is one provision within the 329 pages of the Bill which, if it comes into force, will have a truly profound impact on the real estate sector.
This provision, which has been proposed without any prior government consultation or warning, is the prohibition on upwards only rent review in new commercial leases and put options.
Which leases will the ban apply to?
It will apply to business tenancies in England and Wales covering all commercial asset types (including offices, retail, logistics and data centre properties):
- which are granted after the relevant provision of the Bill comes into force, i.e. it will not have a retrospective effect, and it will not include any new business tenancies which are granted under an agreement for lease, or other contract, entered into prior to the relevant provision coming into force. Currently there is no indication as to when this provision will come into force;
- which contain rent review provisions where the amount of rent payable under the tenancy will, or may, change during the term and the amount of that new passing rent is not known or cannot be determined when the tenancy is granted i.e. it excludes business tenancies which include only fixed/stepped rent review terms; and
- whose rent review terms include an amount to be determined by
reference to:
- the effect of inflation or any other index or multiplier on the rent (i.e. RPI, CPI etc);
- the actual rent for the premises, a hypothetical market rent, or other notional rent, for the premises or other (real or hypothetical) premises; or
- the tenant's turnover.
What does the ban provide?
If the application of the rent review terms in a lease (outlined in paragraph 3 above) results in a reference amount which is lower than the current rent, then any rent review terms in the lease which attempt to implement a new passing rent that is higher than the current rent (i.e. any 'upwards only' rent review provision) will have no effect. Instead, the amount of the new passing rent will be the same as the reference amount, which could be lower than the current rent.
The upwards only rent review prohibition also applies to put options (whereby the tenant can be required by the landlord to take a new tenancy of the same premises with an initial rent to be determined on the terms listed in paragraph 3 above) that may otherwise be used to circumvent the ban.
How will rent reviews be treated on 1954 Act lease statutory renewals?
The prohibition will apply to renewals of existing leases under the Landlord and Tenant Act 1954 that take place after the implementation of the Bill, thereby effectively removing any upwards only rent review provision in statutory lease renewals. It therefore risks creating in the short term a two-tier system of business tenancies – those that will continue to include upwards only rent reviews until renewed, and those which can no longer include such provisions following renewal.
Currently, where the parties cannot agree the rent that will apply on statutory lease renewals, the Court will decide the level of rent payable under the renewed lease based on expert evidence which examines open market rent comparables.
What will be the impact of this ban?
An upwards only rent review ban will mean that the rent could move either up or down at rent review. It may end up being the case that the rental market adjusts to reflect the ban, resulting in initial rents that are larger than would typically be the case under the current system, which could (contrary to the Government's intentions) result in tenants paying higher rents from lease commencement so that landlords are protected from a potential downwards rent review.
The ban could also see a rise in fixed/stepped rent review increases, which again, may end up being more disadvantageous for tenants than a review assessed and applied in the usual way, as landlords may be minded to set a higher fixed rent review on day one of the lease term to protect their interests.
Why has the government introduced this ban?
The Government wants to define the parameters for rent review provisions in commercial leases in England and Wales. However, establishing new rules around the content of commercial leases entered into on an arms' length basis is controversial. The British Property Federation has been reported to criticise the reforms by saying "[i]nterference in long-established commercial leasing arrangements without any prior consultation or warning has no place in the devolution bill."
The Government will be wanting to protect small business tenants, however, with the general shortening of commercial leases, a significant proportion of small businesses won't be taking a lease with a term greater than five years (which is therefore unlikely to include any rent review provision).
The Government has said the reform is intended to ensure that rent review mechanisms reflect market conditions and that artificially restrict rent to upward movements only. What is unclear is whether the Government has carried out any market analysis on the potential impact of this reform and whether, as we mention above, it could result in a negative impact for both landlords and tenants.
What about rent collars?
The Government has said it anticipates avoidance through the use of rent collars (minimum rent thresholds) and so the Government has announced it plans to regulate their use.
Under the Bill, the Secretary of State is granted a regulation-making power to define exceptions to the upwards only rent review ban. This includes the ability to specify permissible parameters for the use of collars and caps. The Government has said a formal consultation will be undertaken to determine these parameters and that examples under consultation might include:
- a flat rule requiring collars to be no less than 10%, 15%, or 20% of the rent payable; and
- a conditional rule permitting smaller collars where a corresponding cap is applied at the same level.
However, it seems that any consultation will follow the enactment of the Bill as the Government has admitted that the detail of this policy design will not be known at the point the primary legislation will be passed.
Is it likely that the Bill will become law?
Fortunately, this provision in the Bill has a long way to go before it becomes law. Landlords will consider this move to be interference on the part of the Government in commercial arrangements over which they should have no influence, and will hope that the proposal will be quietly dropped by the Government during the passage of the Bill through Parliament.
If the Bill passes in its current form, we can expect to see legal challenges against this proposed reform. This would not be the first occasion where the Government may face challenges from landlords in response to its leasehold reform agenda. For example, there is currently a judicial review on human rights grounds in relation to the Leasehold and Freehold Reform Act 2024, where the measures under challenge relate to the calculation of the price payable on enfranchisement, the removal of marriage value and the cap on ground rent in enfranchisement calculations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
