Comeback for commercial upward-only rent reviews

Most leases that predated section 132 of the Land and Conveyancing Law Reform Act 2009 – banning upward-only rent reviews – contained a mechanism that allowed for the passing rent under the lease to be reviewed to market rent but subject to one common proviso: that the revised rent shall be the greater of the rent passing immediately prior to the rent review date or the open market rent, whichever is higher.

This proviso, which effectively prohibits the passing rent under a lease from reducing to below its current level, continues to be the subject of much consternation for those who find themselves in the position whereby the rent they pay exceeds the market rent for their property.

Ireland is emerging from a deep recession where, according to the Investment Property Databank (IPD) indices, rental levels for retail fell by as much as 63 per cent, office by 59 per cent, and industrial by 68 per cent.

What scope is there for rent increases to once again become a feature of the commercial landscape in 2015 and beyond?

We must first recognise that there is, in reality, a two-tier system at play in Ireland: those leases created on or after February 28th, 2010, which, from a tenant’s perspective, benefit from the ban on upward-only rent reviews, and those leases created before that date which, in most cases, contain an upward-only rent review provision.

Ironically, it is those very leases that apparently benefit from the ban on upward-only rent review provisions which are most likely to see increases on review in 2015 and beyond.

To understand why, we must acknowledge that letting activity in the Irish commercial property market preceding the introduction of the new legislation was in a state of utter stagnation. The low take-up levels across all sectors in 2010 had the effect of swinging the power pendulum in the tenants’ favour when negotiating terms for a new lease.

Historically low rents, flexible lease terms with break options, increased rent-free periods, as well as a shift to turnover rents in the retail sector, became the norm.

Against this backdrop, any improvement in the property market and wider economy was likely to result in an increase in activity. This results in competition for space, which in turn places upward pressure on rents.

Nowhere is this more evident than in the office sector, particularly for large grade A office accommodations.

The complete cessation of speculative office construction activity from about 2008, together with the steady inward trickle of foreign direct investment during the downturn – particularly from large US tech firms such as Facebook, LinkedIn and Google – saw the vacancy rate for large grade A office accommodation drop significantly.

Fast forward a few years and, with the improving economy, falling unemployment rate, rising consumer sentiment and increased competition among a certain cohort of office-occupiers for a smaller pool of available suitable accommodation, the result is double-digit rental growth of 31 per cent recorded by IPD for grade A office space in the 12 months to end of the fourth quarter last year.

Those occupiers whose passing rents were set pre 2008 are, in the most part, still significantly over-rented. The current headline rents for grade A office accommodation are still approximately 13 per cent behind their 2007 equivalent.

A similar picture emerges for both retail and industrial which are 53 per cent and 63 per cent behind respectively, according to the IPD indices.

In summary, 2015 is likely to see increased activity in rent reviews for certain office occupiers who entered leases, post-2008 in particular, and who availed of historically low rental levels as landlords now seek to capitalise from the well-documented increase in rents within the sector.

With certain exceptions, such as Dundrum Town Centre and other prime retail locations, the ability to increase rents at review within the retail and indeed industrial sectors, will prove far more challenging.

In many cases, there may well be opportunities to reduce rents for certain classifications of property in some sectors.

Therefore, it is incumbent on landlords and tenants across all sectors, who entered new leases on or after February 28th, 2010, to seek professional advice in order to establish whether their upward and downward rent review provision affords them the opportunity to review their current rent position.

Robert McHugh is a member of the professional advisory services team at DTZ Sherry FitzGerald