Whether residential or commercial property, there is a considerable amount of money to be made by playing your cards right. It’s not only investors that can play the property game, so too can banks. The ruling, per Mark Robert Alexander (As Representative of Property 118 Action Group) v West Bromwich Mortgage Co Ltd , in which some ‘small print’ in the mortgage conditions was held to be enforceable, thereby enabling the lender to increase the interest rate much to the chagrin of the borrower, serves as a useful reminder to landlords for what it feels like to be a tenant and on a receiving end of a demand for more money.
Generally, landlords of commercial property are not on the same wavelength as tenants. Landlord like to be in control, but tenants are in the driving seat shouldering the responsibility, whereas landlords are there for the ride. When a rent proposal is out of proportion and the tenant unaccustomed to the process, the reaction is likely to be one of outrage: ‘how dare they’ followed by ‘what am I going to do?’.
It is not often that landlords are also tenants let alone of the same property, but it does happen with intermediate leases. An intermediate interest is created when the superior landlord (also known as the freeholder) grants a lease to a landlord who in turn grants an underlease to a tenant. The lease between superior landlord and landlord must be for a longer term than the lease between landlord and tenant.
With long-leasehold residential property, rent reviews tend to be fixed increases rather than open-ended. One reason for fixed increase is do with the Council of Mortgage Lenders (CML) preference for security and certainty. With long-leasehold commercial property, the rent review between superior landlord and landlord is often geared, rather than rack rental value. The gearing basis varies depending upon what the parties agreed on grant of intermediate lease, but are generally a fixed increase or percentage of the rack rental value of the premises as defined in the lease.
When the superior landlord intends to benefit from changes in market rental value of the demise, the drafting of the review clause in an intermediary lease requires careful thought because the contractual term is likely to be a very long time, 99 years is common. A factor that might be overlooked by a buyer of the landlord’s interest who becomes an assignee of the intermediate lease. Leasehold investments appeal to private investors because the yield is often substantially more attractive than for freeholds. Since most if not all the terms and conditions in the headlease can be conveyed into the underlease, a intermediate landlord might think himself onto a winner presupposing the tenant does not default.
Such thinking may be mistaken. The fact that the landlord has quite possibly underlet the premises at a rent that is substantially more than the rent the landlord pays the superior landlord does not mean the landlord is shielded from the market forces of a rent review. It is not only intermediate leases that appeal to investors, so too is the superior landlord’s interest. The yield, for what in popular parlance is known as a ‘ground lease’, might be low but for the money one buys much more property and far more potential for capital gain than paying a high price for a run-of-the-mill freehold rack rented or short-dated reversion whose potential is limited or non existent.
Market forces at rent review extend to more than the rent. There is also the matter of timing. There may be opportunity potential for the superior landlord in not implementing the review before the review date, instead delaying, waiting patiently to see what the landlord is planning. In the same way that inexperienced tenants see no point in reminding the landlord of an outstanding rent review, landlords that ignore superiors also become victims of their own shortsightedness. By putting themselves into a state of uncertainty, landlords do themselves disservice by creating problems for any alienation of their interest in the property. Where a headlease review is outstanding, chances of the landlord finding a buyer for the headlease willing to exchange contracts before the review is agreed are remote.
Thinking that an outstanding rent review between superior landlord and landlord has been abandoned when there is nothing to indicate that is indeed the case is symptomatic of a landlord thinking above their station. The difficulty for landlords who find themselves on the receiving end of an outstanding rent review being triggered in consequence of wanting the superior landlord’s consent for assignment is often the shock at the level of proposal coupled with the realisation that the profit rent will be reduced. When the leasehold investment is for sale with a buyer lined up, the prospect of a capital gain is also eroded.
Property investment is not without risk and high yields and low interest rates indicate high risk. Success in property includes protecting the bottom-line, the same principle applies to banks and lending rates. With high risk, it is vital to be on the ball and think ahead. The property game is not for everyone, there are winners and losers. Frankly, investors that get affronted and come unstuck through failure to have their wits about them could be said to be the sort of people the property market could do without.
The Rent Review Specialist