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New lease of life for landlord and tenant

The property market needs more flexibility and competition.

Britain’s commercial property market is highly competitive, yet there is surprisingly little competition when it comes to the terms landlords offer their tenants. Lease agreements typically impose onerous terms including restrictions on sub-letting and regular reviews that can raise rents but never cut them – even if property rentals are falling. More competition is highly desirable, as the government has recognised by reviewing options for reform.

The standard lease is reviewed every five years, but can only be adjusted upwards. The average length of leases has been failing gradually, but they can run for up to 20 years or more for some of the most attractive properties. The resulting rent increases can put tenants under enormous financial pressure, with no possibility of mitigation if rents elsewhere fall.

The practice, prevalent only in the UK, has some bizarre consequences. It encourages landlords to further minimise the risk to their income by handing over responsibilities for repairs and insurance to the tenants – liabilities better borne by a property specialist.

Tenants are not free to sublet property when it would suit their business – they remain liable for the rent for the duration of the lease and often may not sublet at a lower rent. This protects the valuation of commercial property, which is linked to the rent it earns.

And to sustain rents and justify increases at review time, landlords can find it worthwhile to leave property empty, rather than let it at a lower rent. Overall, the system encourages an adversarial landlord and tenant relationship, rather than partnership.

Although the property industry is fighting hard to preserve the system, it has been rightly identified by Gordon Brown, the chancellor, as too inflexible for a modern economy. Elsewhere in Europe, leases are shorter, have fewer restrictions, offer tenants break clauses at rent review dates or raise rents at a fixed rate or in line with indices such as retail prices. There is no evidence that these countries have less vibrant property markets or that investment yields are worse.

The obvious remedy would be to ban upward-only rent reviews, but it would be undesirable to rule out a form of lease that appeals to some categories of tenant. The aim should be to push the industry to offer greater flexibility in leases and more choices to tenants. Some progress has been made towards this under voluntary codes of practice, but a Reading University study found little impact on the market so far.

A better solution would be to set a limit on the length of commercial leases to say, the 9 or 10 years common elsewhere in Europe, with mandatory break clauses if rents rise other than on a rate set in the lease. Such an approach would also encourage landlords to treat tenants more like customers so that they want to renew leases when they expire. And it would place more of the property risk where it belongs – with the landlord, rather than the tenant.

Financial Times: 28.10.04