In a consultative paper released last week, the Office of the Deputy Prime Minister (ODPM) addressed options for legislating against upward only rent review (UORR) clauses in commercial property leases. At this stage, it is not entirely clear how modified lease arrangements will affect CMBS structures, though market sources are confident that the impact, if any, will be minimal.
The legislators are making good on their stated commitment to promote more choice and flexibility in the commercial property leasing market. In the consultative paper, they cite the current UORR clause as a "source of grievance" to many in the commercial property market. Although the ODPM aims to review several options, its findings at this initial stage do not necessarily imply a change in legislation will follow. The consultation period is expected to extend into the third quarter of this year, followed by a final release thereafter, which would detail any definitive change in the legislative stance, market sources said.
"The ODPM is soliciting feedback from various market participants (e.g., financiers, developers, tenants) about the U.K.'s upward only rent review clause common in most lease arrangements," reported analysts at JPMorgan Securities. "The ODPM is seeking to explore alternative leasing terms, since it views UORR clauses as less flexible for tenants in a market downturn."
The ODPM is looking at several potential revisions and/or requirements. These include banning upward only rent reviews, providing tenants with a right to break if the revised rate were above market levels, limiting the lease length and requiring landlords to provide prospective tenants with priced options. How these potential changes might affect the leases found in current CMBS structures is still a matter of debate. Analysts at the Royal Bank of Scotland said that depending on what sort of grandfathering is allowed, the news might prove slightly negative to transaction structures.
In a weaker economic environment, modified lessor options could reduce assumed cashflow into the deals. This could also put pressure on property values, which would, in turn, affect collateral values.
"I don't expect the government to meddle with existing leases," said one analyst at JPMorgan. "All investors, including a growing U.S. investor base, view the strength of U.K. leasing terms as a key strength to this market. I expect that funders will emphasize this to the ODPM. This seems very exploratory."
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