Strong negotiating to seal the deal
Michelle Noble examines rent reviews and considers whether a pharmacist can dispute an increase in their rent…
Rent reviews are common in pharmacy leases, which tend to be granted for longer terms than most commercial leases. Such reviews allow landlords to make periodic changes to the rent for the property, ensuring the sum raised reflects the true value of the property.
The frequency of a rent review is determined by the parties at the outset of a lease, when the heads of terms are agreed. The frequency is influenced by the duration of the lease term, but typically is every three to five years. There are various types of rent review.
The most common seen in pharmacy leases are open market rent (“OMR”) review clauses, and clauses linking the new rent to the increase in an index (usually the Retail Prices Index).
Other types of review include fixed/stepped increases which are determined by the parties before the lease commences, and turnover clauses which are linked to the turnover of the pharmacy business. The latter type of clause has been popular in the retail market recently due to the Covid pandemic.
A rent review clause may be a combination of the methods – it is common in pharmacy leases for there to be an OMR review every three or five years combined with an index-linked review annually or every two or three years.
Historically, rent reviews have been drafted to be upwards only – meaning that the rent would never fall below the rent currently payable under the pharmacy lease. The RICS Code for leasing business premises recommends that rents be adjusted downwards too.
Landlords, unsurprisingly, are reluctant to agree to this, but it is something pharmacists should consider requesting when agreeing new lease terms with a landlord. It is important to note that most rent reviews are not time critical, so even if the rent review date has passed, it can usually still be implemented.
Landlords will often try to delay carrying out a review if there has been no movement or a downwards movement in the rental value. The review is then commenced later, giving the landlord a better chance for a rent increase. Covid saw a noticeable trend for landlords to delay reviews.
Open market rent review clauses
An OMR is determined by looking at similar premises in the area. Rent review clauses of this type usually allow for the parties to try to agree the new rent between themselves in the first instance, but if it cannot be agreed, it is referred to a surveyor for expert determination or arbitration.
A surveyor is directed to make certain assumptions about the terms of the lease and to disregard matters which might otherwise distort the open market rental value. Examples of such assumptions are that the pharmacy is in good repair and that the tenant has complied with its lease obligations.
Matters such as improvements made by the pharmacist (at the pharmacist’s cost), any initial rental discounts or rent-free periods provided for fitting-out, and the goodwill built up in the pharmacy business would be disregarded.
There are several clauses within a lease that can affect rental value. The use clause can have a significant effect – if the lease allows the premises to be used for a variety of purposes the OMR is likely to be higher than if the use was restricted. Pharmacists should therefore ensure when negotiating lease terms that they can use the premises for every purpose they require but not beyond that.
Indexed rent review clauses
Indexed rent reviews are linked to inflation rather than market rents, and calculated using a mathematical formula. Although RPI is the most commonly used benchmark, some leases will refer to the Consumer Price Index (“CPI”). A ‘collar and cap’ method may be used, which caps the maximum increase or, if the formula produces a rent that is lower than the collar, the revised rent will be bumped up to the level of the collar.
Indexed rent reviews are becoming more popular, perhaps due to shorter lease terms but also to avoid both parties incurring costs in determining the OMR.
Turnover rent reviews are also becoming increasingly popular as the rent is based on either pure turnover or a reduced based rent (often fixed at the beginning of the lease term), topped up by a turnover rent (an agreed percentage of the tenant’s turnover). Tenants like these because if they stop trading, no rent or only the base rent is payable.
Can you influence a rent review?
In advance of an OMR review, pharmacists should gather information on local similar premises, equipping them with knowledge of what the rent of their pharmacy should be. This will allow them to negotiate the rent directly with the landlord and ideally avoid determination by a surveyor, which can be costly.
Pharmacists will be in a stronger position to negotiate directly with the landlord if they have been observing and performing the lease covenants and paying their rent on time.
As indexed rents follow a formula, they cannot be influenced, but pharmacists should check the calculations.
In advance of a turnover review, pharmacists should collate all financial information on the business and ensure that they understand how turnover is calculated. What ‘turnover’ encompasses will differ from lease to lease.
The pharmacy lease will dictate the method and timeframe for disputing the outcome of a rent review. If the review has been referred to an expert or an arbitrator, their decision is usually binding except when there has been a significant error.
The above is a general overview and we recommend independent legal advice is sought for your specific concerns. Michelle Noble is a member of the pharmacy transactions real estate team at Charles Russell Speechlys – firstname.lastname@example.org