On 12 February 2015 the Bank of England governor Mark Carney launched the Bank’s latest inflation report.
In his speech he raised the prospect of the UK entering a period of deflation, with the below-target inflation currently being experienced largely blamed on low oil prices.
The last time headline inflation was negative was March 1960. Recently, indexation clauses for rent reviews, usually referencing RPI or CPI, have become more popular. Such clauses can be attractive for their clarity and certainty, providing a quick and easily understood means of deciding the reviewed rent. There are added benefits such as avoiding the expense of a disputed market rent review every few years and the costs of going through arbitration.
What, then, might a period of deflation mean for rent reviews under these leases?
Despite the RICS-endorsed Code for Leasing Business Premises discouraging headline rent reviews, most commercial leases still contain upward-only rent reviews. Because of this, it may be that any period of deflation that does happen will have little effect on commercial rent reviews, even where leases contain indexed rent review clauses, as the existing rent will continue to be payable on review. This reviewed rent may, however, be well below the market rent. If parties have followed the code as well as adopted an RPI-based rent review, they could see falling rents in a rising market.
What might this mean for commercial landlords and tenants? Landlords without upward-only rent review provisions may look to exercise break clauses and renegotiate rent review clauses in any new lease. In the absence of a break clause, landlords may explore any other means of taking back the premises if it has become less profitable after an indexed rent review.
Tenants who might have been considering moving or exercising a break clause may reconsider if the reviewed rent is going to be advantageous to them. On renewal, protected tenants would undoubtedly resist any proposal by a landlord to move from an indexed rent review to a market rent, which a landlord may struggle to justify.
It is likely that the spectre of deflation will now be in parties’ minds when negotiating either new leases or renewals. Landlords will want to ensure that rental levels are maintained and seek market rent reviews, with tenants looking for indexation terms that are favourable for low rental increases. It may lead parties away from adopting the code’s proposals and a continuing insistence by landlords and lenders on upward-only rent reviews in new commercial leases.
Helen Wheddon is a partner at Stevens & Bolton LLP