PSG tackles index-linked rent reviews

As regular readers of the Journal will be aware, the PSG saw the advantage of having Scottish versions of the Model Commercial Leases, so that standardised leases are available north and south of the border, saving both negotiating and management time. The PSG versions of the four suites of the Model Commercial Leases (office, retail, industrial & logistics and food & drink) are available on the PSG website.

The MCL have other lease management documents available. The PSG already has its own pre-existing versions of some of them, such as licences for works, rent review memoranda, etc. However, we considered that there was merit in kilting the MCL index-linked rent review clauses, because there are many pitfalls for the unwary in drafting these clauses.

Index-linked rent reviews may be used where the parties are looking for more certainty on review, or for unusual buildings for which there are no comparables, making it difficult to carry out an open market rent review. 

We have just published the PSG version of the index-linked rent review clauses, which can be found on the leases page on our website. There are two clauses, which are both drafted for an upwards-only review. 

The first clause is a simple index-linked clause which may be used for either an annual or other periodic review with an optional cap or collar, or both. The cap will set an upper limit on the rent increase, and the collar will set a lower limit on the rent increase. There is one calculation on the rent review date using the basic formula set out below (subject to the cap and collar if there is one). 

The second clause provides for five-yearly reviews with an annual optional cap or collar, or both, effected by notional annual calculations. Although the rent is only reviewed every five years in this clause, the notional rent needs to be calculated each year during the rent review period as the increase in the index will be applied annually to the notional rent from the year before, effectively compounding the increase in the rent and producing a higher rent on the review date. 

There are separate guidance notes which include worked examples using both styles of clause. The first worked example uses the simple clause, and the second and third examples use the notional annual calculations (one with no cap and the other with cap and collar). We recommend including a worked example in the lease itself when using the second clause, particularly if there is a cap or collar, so that all parties are clear how the clause will operate.

The clauses are drafted for either the consumer price index (CPI) or the retail price index (RPI). Another index may be used in place of RPI or CPI, and if another index is chosen we recommend that it is one that is easily available without cost to both the landlord and tenant.

The choice of index used will be a matter of negotiation between the parties, as different indices will produce different results, some being to the advantage of the landlord and some being to the advantage of the tenant. 

RPI is no longer a national statistic (it lost this status in 2013). It is still being published, however, and so it is used in index-linked rent review clauses, possibly because it is attractive to landlords as it generally results in a higher rent on review.

The basic formula we have used is:

R = A x C/B, where:

R is the revised rent payable from the rent review date;

A is the rent payable (ignoring any abatement of rent then in force) under the lease immediately before the relevant rent review date;

C is the current figure, i.e. the index figure for the month three months preceding the rent review date; and

B is the base figure – on the first rent review date this will be the index figure for the month three months preceding the term start date; on subsequent reviews it will be the current figure from the previous rent review date.

All index figures are published in arrears, so if for example the rent review date is 1 April the most recent index figure available will be the figure for February. We have therefore suggested using the index figure for the month three months preceding the rent review date, to ensure that the index figure is available. The base figure for the first rent review takes into account this three month differential by using the index figure for the month three months preceding the term start date, so that there is a full calendar year between the base figure and current figure the PSG website.