ESTON-analysis – Rent review

The idea of rent review is not yet so well known in Hungary, although it is commonly used across Europe in all segments of the real estate market. In case of adoption, the landlord has the right to review the rent periodically (usually every 5 years) during the whole period of the lease. According to Western-European practice, the clause generally takes effect after 5 years, and protects both landlord’s and tenant’s interests. As a consequence, with the co operation of a third party (expert, real estate professional) based on actual market information, a new, real rent level will be defined.

By using the method of rent review, landlords can keep pace with market rent levels. The rent corrected in this way always accurately reflects the market changes that have occurred since the original signing of the contract. This clause differs from contract to contract and is frequently very detailed and difficult to interpret without competent expertise. As for the various types, some may be adjusted to market rents or increased by a fixed amount. In time of crisis, rent review would be a particularly advantageous option in the short run for property owners, as current market rents are far lower than those stated in previous lease contracts.

Road to rent review

A less successful new office project that was handed over this year openly advertised its very low rent levels in the first half of the year, which created a big stir among professionals, and the news reached potential tenants as well. Due to this, confident tenants, who wanted to rent cheaper, tried to bargain everywhere else on rents already under the combined effects of new supply continuously coming to the market and dropping demand. While rents had been an average 12-14 €/sqm/month for years, prices dropped by 10-30% under the effect of the crisis.

Exchanging roles: landlords come to their senses

In years past, owners clearly preferred long-term lease contracts. The situation, i.e. mainly the attitude of landlords, has changed since then. While in the past few years, tenants preferred to quit or reduce their area before the end of the lease contract, now owners require contracts for shorter periods, mostly for 1-3 years. It is easy to explain the owners’ behaviour hiding behind this unexpected turn: some of them are already thinking positively and projecting increases in rents, mainly projecting declining development volume by 2011. The increase can also be assisted by such external factors as the gradually resurgent local and international economic environment. This could result in settlements of further Shared Service Centres in Hungary; therefore, need may arise once more for huge chunks of space, and demand may recover. The consultants of Eston International believe that low rents – compared to overall European levels – and the transformed market environment induced by the crisis would make it necessary to insert a clause to the lease contract similar to or corresponding with rent review.

Base pillar of cooperation

The rent review system widely used in Western Europe would encourage long term collaboration on the part of both landlords and tenants. If they do not stipulate a similar option now, current leases on low rents will be due in 3 years, and therefore none of the landlords will be willing to detain tenants who lease on lower levels when rents are already higher. Those tenants who concluded deals few years ago on the then healthy market of higher rents could realise that the once established and continuously indexed prices in the lease are now moving in the opposite direction of the market tendency. Therefore a kind of “breakpointâ€? could occur in the good business relationship while renegotiating or terminating the contract, which could be avoided in advance by inserting the clause. It is not so easy to introduce it, however, as there are many pros and cons.

One of the counter-arguments derives from the period of the lease itself in the UK, where rent review is widely used; the average lease period is about 10 years, compared to the average 4 in Hungary. Obviously you have to make more compromises in the course of a 10-year-contract than a shorter one. At the same time the average length of lease periods is getting shorter every year, according to statistics. The average lease period of 25 years, once considered institutional in the UK, has been declining for almost 10 years. On top of these factors, in reference to Hungary, it has to be taken into consideration that flexibility, the possibility of extension or shrinkage and the alteration of conditions while avoiding conflicts are the most important for companies nowadays and legal regulations should be adjusted accordingly as well.

By creating adequate conditions and with the close collaboration of market players, an exceptional initiative could evolve, which in addition to the introduction and spreading of the rent review concept, would also foster the development of the industry. Adopting this new direction could control erratic market movements, the vision of the transparent market could be a reality at last, and an image of the Hungarian real estate market as serious and clear-cut would emerge in the eyes of investors.

Tips for tenants:

– If you are planning to move within 1 year, it is worth considering expert services, as a real estate consultant who knows the whole market could reach higher saving for you.
– A professional consultant is the best option in case your planned move is within 1-2 years, as you could save significant amounts with the renegotiation of your existing lease.

For further information please contact our experts or visit our site at www.eston.hu and read the full issue of Property Watch under „Our publicationsâ€?.