Leases and underleases - Rent and rent review mechanisms

Learning Outcomes

After reading this article, you will be able to identify the legal characteristics of leases and underleases, explain the main types of rent and rent review mechanisms in commercial leases, and apply the rules for resolving rent review disputes. You will also be able to distinguish between fixed, index-linked, turnover, and open market rent reviews, and understand the practical and legal implications of each for SQE1 assessment purposes.

SQE1 Syllabus

For SQE1, you are required to understand leases and underleases from a practical and legal standpoint. Focus your revision on:

  • The legal definition and essential features of leases and underleases
  • The process and requirements for granting leases and underleases
  • The main types of rent review mechanisms in commercial leases
  • The legal and practical operation of rent review clauses, including open market, fixed, index-linked, and turnover reviews
  • The procedures for resolving rent review disputes between landlords and tenants

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. What are the essential legal characteristics of a lease?
  2. What is the difference between an underlease and an assignment?
  3. Name three common types of rent review mechanisms found in commercial leases.
  4. What is typically the effect of a "ratchet clause" in an open market rent review?
  5. How are disputes over rent review usually resolved if the parties cannot agree?

Introduction

Leases and underleases are central to property transactions in England and Wales. For SQE1, you must be able to identify the legal requirements for creating leases and underleases, explain how rent is determined and reviewed, and apply the rules for resolving rent review disputes. This article covers the key exam-relevant principles and practical issues.

Leases and Underleases: Legal Structure

A lease is a legal estate in land that grants exclusive possession for a fixed or periodic term in exchange for rent. The lease sets out the rights and obligations of both landlord and tenant.

Key Term: lease
A legal estate in land granting exclusive possession to a tenant for a certain term in exchange for rent.

An underlease (or sublease) is a lease granted by a tenant out of their own leasehold interest, for a term shorter than the tenant's own lease.

Key Term: underlease
A lease granted by a tenant (not the freeholder), for a term less than the tenant's own lease, creating a new landlord-tenant relationship below the head lease.

A valid lease or underlease must be in writing, signed as a deed, and, if for more than seven years, registered at the Land Registry.

Granting Leases and Underleases

The process for granting a lease or underlease typically involves:

  • Drafting and agreeing the lease terms (including rent, term, and covenants)
  • Deduction and investigation of title by the landlord
  • Pre-contract searches and enquiries by the tenant
  • Obtaining any necessary consents (e.g., superior landlord's licence to underlet)
  • Execution as a deed and, if required, registration

Key Term: licence to underlet
Formal written consent from the superior landlord allowing a tenant to grant an underlease, often required by the head lease.

Distinguishing Underleases from Assignments

An assignment is the transfer of the tenant's entire leasehold interest to a new tenant. An underlease creates a new, subordinate leasehold interest, while the original tenant remains liable to the superior landlord.

Rent in Leases

Rent is the consideration paid by the tenant for the right to occupy the premises. The lease will specify:

  • The amount of rent
  • The payment frequency (monthly, quarterly, etc.)
  • The method of payment
  • Any rent deposit or security

Key Term: rent
The periodic payment made by the tenant to the landlord under a lease for the right to occupy the premises.

Rent Review Mechanisms

Rent review clauses in commercial leases allow the rent to be adjusted at specified intervals. The main types are:

Key Term: rent review
A contractual mechanism in a lease allowing the rent to be adjusted at set intervals according to a defined formula or process.

Types of Rent Review

  • Fixed Increase: Rent rises by a set amount or percentage at stated intervals.
  • Index-Linked: Rent is adjusted in line with a published index, such as the Consumer Prices Index (CPI).
  • Turnover Rent: Rent is calculated as a percentage of the tenant's business turnover.
  • Open Market Rent Review: Rent is reset to the current open market rental value, usually every 3–5 years.

Key Term: open market rent review
A rent review where the rent is adjusted to the market rent for comparable premises at the review date, as determined by agreement or valuation.

Operation of Rent Review Clauses

A rent review clause will specify:

  • The review dates (e.g., every 5 years)
  • The review method (fixed, index-linked, open market, etc.)
  • Any "upwards only" provision (ratchet clause)
  • The procedure for agreeing or determining the new rent

Worked Example 1.1

A lease of a shop provides for a rent review every five years to the open market rent, with a ratchet clause. At the first review, the market rent has fallen below the initial rent. What is the effect?

Answer: The ratchet clause means the rent cannot fall below the previous level, so the rent remains unchanged despite the market decrease.

Worked Example 1.2

A tenant pays rent based on 7% of monthly sales (turnover rent). In a slow month, sales are £10,000. What rent is due?

Answer: The rent for that month is £700 (7% of £10,000).

Rent Review Disputes and Resolution

If the landlord and tenant cannot agree the new rent at review, the lease will usually provide for referral to an independent expert or arbitrator. The expert's or arbitrator's decision is binding.

Key Term: independent expert determination
A process where a neutral expert is appointed to determine the new rent under a rent review clause, with their decision being final and binding.

Key Term: arbitration
A dispute resolution process where an arbitrator decides the rent review dispute, with the decision binding on both parties.

Worked Example 1.3

A lease provides for open market rent review. The landlord and tenant cannot agree the new rent. The lease states that an independent expert will decide. What happens?

Answer: The dispute is referred to the expert, who determines the new rent. Both parties are bound by the expert's decision.

Exam Warning

Rent review clauses are often strictly interpreted. If the lease says rent can only go up ("upwards only"), the tenant cannot benefit from a fall in market rent at review.

Summary

Rent Review TypeHow It WorksTypical Effect
Fixed IncreaseRent rises by set amount/percentagePredictable, may lag market
Index-LinkedRent tracks published index (e.g., CPI)Follows inflation
Turnover RentRent is % of business turnoverVaries with tenant's sales
Open MarketRent set to current market valueReflects property market

Key Point Checklist

This article has covered the following key knowledge points:

  • The legal definition and requirements for leases and underleases
  • The distinction between underleases and assignments
  • The process for granting leases and underleases, including the need for a licence to underlet
  • The main types of rent review mechanisms: fixed, index-linked, turnover, and open market
  • The operation of open market rent review clauses and the effect of ratchet clauses
  • The procedures for resolving rent review disputes, including expert determination and arbitration

Key Terms and Concepts

  • lease
  • underlease
  • licence to underlet
  • rent
  • rent review
  • open market rent review
  • independent expert determination
  • arbitration
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Pleased to share that I have successfully passed the SQE1 exam on 1st attempt. With SQE2 exempted, I’m now one step closer to getting enrolled as a Solicitor of England and Wales! Would like to thank my seniors, colleagues, mentors and friends for all the support during this grueling journey. This is one of the most difficult bar exams in the world to undertake, especially alongside a full time job! So happy to help out any aspirant who may be reading this message! I had prepared from the University of Law SQE Manuals and the AI powered MCQ bank from PastPaperHero.

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