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Rent review law to change property market entirely

Legislation endeavouring to abolish the upward-only rent review is shaking the foundations of the property establishment. In most leases it means rents cannot fall below the prevailing rate when the rent is reviewed, usually every five years.

What is curious about the proposal is that it is in essence seeking to secure by force something that the market could, and is, providing anyway.

A potential tenant is currently perfectly within its rights to seek an upward and downward rent review within a new lease (in precisely the same way as a house buyer is entitled to seek a fixed or variable mortgage from the bank).

If all tenants demanded this clause landlords would have no option but to concede. In essence the debate is actually about the alignment of the landlords’ and tenants’ interests and is largely only relevant in respect of retail property.

In this regard landlords and their leases have been reacting accordingly. Leases that cater for base rents of 70% to 80% of market value with turnover top-up have been around for some time.

Similarly, 100% turnover-related rents are also on the increase and essentially represent the majority of rental deals done this year.

Consequently, whether as a result of the natural evolution of the market or indeed the abolition of upward-only rent reviews, investing in property will no longer be about the lease or even the tenant covenant, but the specific property. Private investors, institutions and bankers alike have, to date, been looking at properties as financial instruments. Cash flowing out via lease payments with the benefit of upward-only reviews in the context of a given tenant’s covenant to arrive at an acceptable return has been the flawed foundation of property investment over the past decade. The property adviser’s role in the exercise was often relegated to a rubber-stamping valuation exercise a few days before contract signing. This uninformed approach to property investment has been the stronghold of many naïve investment syndicates over the past few years and explains the success of the myriad of bank sales and leasebacks.

So if a newly let shopping centre is acquired from here on it will all be about the ability of that property now and in the future to justify its rent role. Sustainable rents will be the focus.

In this regard property becomes a living breathing commodity and not a financial instrument and understanding it will be the key to successful investment. Supply and demand will form the foundation of this analysis in the unregulated development markets such as the office and industrial sectors.

However, property-specific issues such as running costs, occupational obsolescence and ongoing refurbishment capacity will be of critical importance.

For the regulated retail development market it is much more complex. It is not just about the physical property and the likely supply and demand to the sector but also about understanding the tenants’ business and what makes them profitable in that specific property.

This sector above all others will see an alignment of interest between the landlords and tenants and understanding it will be key.
Rod Nowlan, Investment Director