RPI inflation-linked leases ‘punitive for most occupiers’ – GVA
With many of the leases signed at the height of the market in 2007 coming up for their first rent review this year, in a noticeably different market, GVA has looked at the best rent review options for different sectors – and considers the case for sticking with upward-only rent reviews (UORR) or moving to one of the alternatives
The UORR clause “is a remnant of an era when leases were for 25 years and it provided greater protection to developers, landlords and lenders alike against turbulent rental growth,” GVA notes in its new research. It was introduced in the 1950s to combat the detrimental role inflation played on leases that were sometimes more than 90 years in length.
Modern leases have much more flexibility and their length has been reduced sharply – the latest IPD/BPF lease review shows that the average length for a commercial property lease in 2011 was 4.8 years to the first break clause, down from 8.7 years in 1999. “Almost three quarters of all leases in 2011 were for five years or less,” the firm adds.
GVA considers whether occupiers with UORR will be at a disadvantage to those with leases reviewed under alternative measures, such as RPI inflation or turnover. It concludes that while RPI inflation-linked leases appear to be a more attractive proposition, “the contrasting directions of open market rental value growth and RPI means that it would be punitive for most occupiers to accept these terms”. RPI inflation has increased by 18% since the market peak in 2007 compared with rental falls across the board in commercial property. On longer leases granted since 1987, GVA points out, RPI inflation has risen by 140% while the only sector to match or beat this in terms of rental growth is out-of-town retail warehouses.
For offices, GVA says that there is very little sense in agreeing to an RPI-linked lease, particularly for office space in the City and outside London, given the likely movement of average rental levels. Within retail, the firm says that “with the possible exception of retail warehouses, where average rents are set to rise by 9% in the five years to 2017, RPI inflation-linked rent reviews are unsuitable for standard retail and shopping centres”. And in the industrial sector, GVA notes that headline rents have remained subdued in many markets due to oversupply. “Many leases signed on an UORR basis in the early 1990s will have seen rental commitments change very little, having been over rented until the late 2000s, a problem now affecting recently signed leases on RPI inflation-linked reviews,” it adds.
It could be argued that a true UORR no longer exists, GVA says, given the prevalence of shorter leases and with rental values still below peak levels. “For many leases granted in the current market, the tenant can effectively incorporate an upwards/downwards rent review by negotiating a lease term of less than five years,” it points out.
“The use of short leases, particularly in secondary properties across all sectors, negates the need for a tenant to commit to UORR or RPI inflation-linked increases,” GVA concludes.
