Commercial property leases vary considerably, from large-scale shopping complexes to offices. The types of rent paid, how they are calculated and when they are paid, also vary. Both landlords and tenants will need to consider carefully the commitments that they make relating to rental payments (including any provision for change over long periods) when entering into a commercial property lease. Beyond striking a commercial deal on the initial rent rate, it is important for both parties to be clear on what a lease provides for in respect of rent and related matters.
In this article, we cover:
Types of rent payable
Rent is a basic feature of any commercial property lease. Most commercial leases include provisions which provide for the payment of rent by the tenant over time. Base rent is commonly set at a market rate and subject to rent reviews to ensure that the landlord continues to receive payments in line with the prevailing market conditions throughout the term of the lease.
The following types of rent are common within commercial leases:
This is the basic rent payable, commonly reflecting the market value and paid in consideration for the landlord making the property available to the tenant.
Insurance rent is any additional rental payment due to cover the cost of insurance.
Service charge rent
Service rent is an additional rental payment designed to cover the cost of services to the premises.
The insurance rent and service charge rent are not rents in the sense that the landlord is making money from them, but they are to reimburse the landlord for the costs they have incurred. They are often referred to as ‘rents’ in a lease though as it then makes it easier for the landlord to recover them (for reasons that fall outside the scope of this article).
There are, however, various other terms used, relating to the subject of rent and these include:
This term is ordinarily used with reference to a nominal rent. It is common where a rent premium is payable upfront and, therefore, any ongoing rent is nominal and not by reference to the market conditions. This is often seen to be referred to as a ‘peppercorn’ rent, which is essentially nothing. However, it is now becoming increasing common that leases are drafted on the basis that the landlord will charge £1 per annum instead of a peppercorn, but this £1 is never collected in practice.
Market rent is a rent which reflects the prevailing market conditions. It is the rent that could be obtained if the property was available on the open market. Market rent is sometimes referred to as ‘OMRV’ (Open Market Rental Value).
Whilst a lease is ongoing, it will also be common to hear open market rent defined as the rent that it would be adjusted to if hypothetically the property was available to let in the open market at the relevant date. As part of making such hypothesis, the lease will normally include a number of assumptions and matters to be disregarded (for example, use type, state of repair). What is assumed and disregarded can significantly impact on a final determination of the open market rent.
This is similar to ground rent. It is a nominal rent that is commonly paid in long leases. Often a peppercorn rent will be £1 per annum but can be defined as ‘one peppercorn’.
A rack rent normally means the same as market rent. It is the best rent that can be obtained on the open market.
Indexed rent/RPI rent
Indexed rent refers to the fact that any changes in rent are linked to an inflationary index. An example of this may be the Retail Price Index (RPI). Index-linked rental increases are common, although can result over time in the rent becoming out of step with true market rent (where the index does not track the relevant property market). A landlord may wish to ensure that rent is upwards only, further they may look to have increases at the greater of an index and the market. A prudent tenant would look to limit how much the rent can increase by upon such a review.
Turnover rents are more common in the retail sector. This defines a type of rent that is pegged to the turnover of the tenant at the premises i.e. the higher the turnover, the higher the turnover rent. Turnover rent is usually paid in addition to base rent, but allows the landlord to share in some of the risk and reward of the tenant’s business. Landlords can often be wary of this approach though as it will be heavily reliant upon the tenant running the business successfully in order to receive higher rents.
A variation of this is a percentage lease. This is where the tenant will pay a base rent, but in addition will pay a rent based on a percentage of a particular indicator (such as profit or footfall).
FRI is an abbreviation for ‘full repairing and insuring’ obligations of the tenant. If the tenant takes on a lease of a whole building they will be fully responsible for repairing the building and covering the cost of the buildings insurance policy. If their lease is of part of the building, they will be required to contribute a fair proportion of the cost of repairing and insuring the whole building. Most commercial leases are prepared on this basis. The obligations taken on by a tenant to repair the property may have a bearing on rental payments.
When is rent paid?
Rent is usually paid as follows:
- as a rent premium, upfront: this is common for long leases
- on a periodic basis: this is commonly on a monthly or quarterly basis
What is load factor?
Load factor is the term used to define the method of calculating the total monthly rent based on area (in particular taking into account shared use of a common area.)
A gross lease is a form of lease where the tenant pays a fixed rent which includes the cost of all other ownership related expenses (such as utilities, taxes, all of which are borne by the landlord). The term ‘gross’ therefore signifies that the rent payable is the total gross sum due from the tenant.
A net lease is distinguished from a gross lease, in that it requires the tenant to pay some or all of the expense of the property, in addition to the normal rent.
Reference to ‘Single net leases’, ‘Double net leases’ and ‘Triple net leases’ signify the number of expense types met by the tenant (of taxes, insurance and maintenance and repair).
Long term leases and rent reviews
Long term leases (where value for the property is recovered by the landlord through regular rental payments, not upfront premium), often include rent review mechanisms and opportunities for the lease to be terminated (break dates).
The mechanism for rent review is ordinarily set out within the lease. It will describe the frequency of the reviews and how the rent will be determined. It is typical for rent to be reviewed every three to five years. Short term leases are unlikely to include rent reviews.
As noted above, rent is commonly determined by reference to an index or the open market. The open market rent is impacted by the local area and general level of rents. The market may also vary depending on the type of use of the property.
A lease may specify whether improvements made to the property are taken into account for the purpose of rent review or whether they will be disregarded.
Typically, a lease will provide that the landlord will be permitted to inform a tenant of a new rent following a rent review. The tenant will commonly have a right under the lease to object to any revised rent. After that, a dispute may be referred to an independent expert (such as a surveyor, appointed by the parties, or in default of agreement by a reputable body) for determination.
The interaction between rent payments, rent review and break dates is important. Careful consideration should be given to rent payment dates and rent review dates. A tenant should ensure that any rent payment dates fall after a rent review or break dates. This is to avoid:
- rent being paid in advance (which could be a considerable sum if rent is paid annually or quarterly), shortly before a lease is due to expire. The tenant may then suffer a cash flow impact and/or credit risk on the advance
- any rent review taking effect retrospectively to the previous rent payment date (which may be a lengthy period if rent is paid annually or quarterly).