The Retail Note - Upwards-only rent reviews: remember them?

Key Messages

• The proposed ban on UORRs would have limited impact on the Retail sector
• This despite helping the High Street being one the key motivating factors
• The proposed ban would only apply to new leases, rather than existing ones
• Very few new Retail leases have UORR restrictions in any case
• A very different story 20 – 30 years ago, but Retail has moved on
• Banning UORR will not have the desired effect of driving down Retail rents
• Retail rents have already undergone substantial rebasing
• Affordability does not always go hand-in-hand with vacancy
• Retail has already moved to an open / ‘free’ market model by default
• For Retail, Government intervention is far too late…
• …and would be more effectively channelled into business rate reform
• Other property sectors may have alternative views
• There are a multitude of other considerations.

Certain sections of the property industry are up in arms. Seemingly from nowhere, the UK Government has put forward a proposal to ban upwards-only rent reviews (UORRs), a landlord-friendly mainstay of UK property markets. But any outcry emanates as much from the lack of consultation as it does resistance to proposed change.

The proposals are highly nuanced, as have been the reactions from various factions within the property community. These are encapsulated and explored in a cross-sector Knight Frank Paper. A clue in the fact that this is a Retail Note, my lens is firmly focused on the high street implications.

Some context

Despite the lack of prior consultation, this has been mooted a number of times in the more distant past. The impact assessment paper highlights that self-controlling mechanisms have been ineffective and the intent is very clear and is consistent with the Government’s aim to rebalance the power in favour of tenants. So, it is not a complete bolt-from-the-blue.

Two important factors to note. Firstly, the proposed ban will apply only to new, rather than existing leases, so any change will be less sweeping that it could have been. Secondly, it is still a proposal, rather than a binding law. The proposed legislation is at an early stage. Similar major reform bills, such as the Renter’s Rights Bill, have taken ca. 10 months to become law. Delays are likely with this bill – it must still pass a second parliamentary reading currently scheduled for 2 September and stakeholder consultation and lobbying (which is likely to be considerable) could slow progress.

In essence, it may take time to become law. Or it may not even become law at all.

The ‘trodden path’ view from Retail

Ironically, this is all Retail’s fault. Not really, but a lot of the Government’s rationale appears to be driven by ham-fisted efforts to help the high street, so all property is being tarred with the same brush. In particular, the bill highlights the ‘blight’ of vacant retail units and suggests that lower rents would enhance high streets and town centres and even lead to increased investment.

While I am 100% supportive of any measures that improve our high streets and have been highly critical of Governmental (non) intervention in the past, the thinking behind this is beyond naïve and woefully out of touch with reality.

Retail has been singled out as one of the driving forces behind the proposal to scrap UORRs and, by implicit extension, one of the key beneficiaries if the move comes to pass. If the latter notion is questionable, the former is significantly time-lagging. All the same, the retail market provides an interesting blueprint as to what the landlord – tenant relationship might look like in a post UORR world.

Historically, retail did become synonymous with UORRs, retail occupiers continually calling them out as an inequitable and unfair constraint to them doing business. The balance of power lay firmly with landlords, retailers were at the mercy of an ever-spiraling cost base over which they had very limited control. There was a constant chorus of discontent from retailers in opposition to long (25 year) leases, subject to UORR.

The operative word here is ‘historically’. The Retail market has evolved significantly over the last 20 years, as much by default as by design, with the market undergoing deep-seated structural change. The relationship between landlords and retail tenants has moved on considerably as part of this process of change, as have lease agreements.

In essence, UORRs are a legacy issue in retail, rather than the status quo. Very few leases agreed in recent years or going forward contain UORR obligations. Tenants have sought far greater flexibility generally and in the midst of this, more rigid bastions such as UORRs have gradually fallen by the wayside.

Being completely frank, I’d almost forgotten the UORRs were even a thing, so infrequently do they come up in conversation in Retail these days. Obviously, they are still prevalent in other property sectors, but in Retail it feels we have already moved on. Not necessarily to a better place per se, but to a very different, dare I say, more complex place.

No benefit to retail – thanks but no thanks

In this regard, the proposed changes in legislation are likely to have minimal impact on the Retail sector, in so far as they only apply to new leases, rather than existing ones.  Few new Retail leases have UORR restrictions in them anyway, so there’s nothing much to ban. Those legacy ones that do still have UORR clauses may be renegotiated or will just wash through until they expire and then re-signed without UORR.

So, any notion that the change in legislation will benefit the retail sector and ‘breathe new life into the high street’ is woefully misguided. Twenty years ago, it would have made a positive difference, but not now. Government intervention is late - and now needless.

Any lobbying (or whinging in its most common form) from the Retail sector now focuses squarely on business rate reform, rather than the ‘old news’ of UORR. As for the notion that the proposed ban will help drive down Retail rents is again out-of-touch in the extreme. Any expectation that this will stymie rental growth and bring high street rents to a more affordable level rides roughshod over what has happened over the last 20 years, which have already seen massive rebasing in rents (by -8% between 2008 and 2013 and by a further -22% between 2017 – 2022). Rents have already come down to a low plateau and in many cases, are as affordable now as they will ever be. Banning UORR will not move the needle one way or another.

Retail – a parallel world to UORR? 

In short, retail has moved on significantly from rigid UORR leases. They have been replaced by a multitude of other options, bringing a suite of alternatives into play. In general, leases have reduced significantly in length (25 years to 10 or just five), with multiple break options (landlord/tenant/mutual).

Nearly all leases on unit shops these days are five-year leases with no review. 10-year leases typically have a break at five, effectively allowing the tenant to reset the rent and negate the simultaneous review. Landlords and tenants will invariably agree fixed or index-linked uplifts anyway, rather than open market reviews.

There are also a whole host of potential variations of terms that go beyond lease length e.g. turnover rents or TOC (total operating costs) deals, bringing negotiations not just on rent but service charges, business rates and even insurance into play. Tenants effectively recognising that there are many more occupational cost levers to pull than just negotiating on rent.

Of course, all this is almost impossible to quantify. As much as I would like them, I do not have figures on the proportion of retail leases that are still subject to UORR readily to hand. But by way of immediate example, I am currently reviewing a full 300-strong Tenancy Schedule for a due diligence on a major (though anonymous, for obvious reasons) shopping centre.

300+ tenants, 300+ different lease types? Not quite, but not a million miles away. Lease lengths varying from three to 100+ years, but the majority on 5 or 10 years. For all intents and purposes, fewer than 20 on UORRs. In fact, 16 different terms of Rent Review. A multitude of different break options. More than 50 on turnover-rent deals, these ranging from ca. 4% to 20%. A handful on TOC deals. Around 10 with concessions on Service Charge payments.

Approximations and generalisations maybe, but you get the general picture that there are any number of permutations and combinations. As far removed as every tenant subject to the same rigid terms and slave to UORRs as you could possibly imagine.

Final thoughts

If retail is a blueprint for other sectors in the event of the UORR bill being passed, the message is that landlord – tenant relationships will be less rigid and the former will see less certainty than they may have become accustomed to. More uncertainty, far more complexity, but the trade off is far greater flexibility and transparency - and that may ultimately be mutually beneficial for both landlords and tenants.

Twenty years ago, retail lobbied hard against UORR leases, and this may only be becoming a reality now. Hopefully we won’t have to wait 20 years for the reform to business rates the retail sector is clamouring for now – and so desperately needs. If any government is predisposed to bringing about positive change to leasing structures and easing burdens on high street retailers, business rate reform should surely be the obvious place to start?

As outlined, these are my views purely from a Retail lens. A multitude of other perspectives from my colleagues across Knight Frank’s other sectors and service lines are collated in our wider UORR Paper.