The contribution of upward-only rent reviews to the capital value of UK property

The aim of this paper is to provide a response to suggestions that the removal of upward-only rent reviews (sometimes known as ratchet clauses) would reduce commercial property asset values in the UK. The paper also seeks to estimate the amount of the reduction. It argues that the fall in the capital value of commercial UK investment property will be a function of changes in risk/return characteristics which, when set within the framework of the current leasing structure and the expected cash flow determined thereby, manifests itself in changes in investment yields. Because the property market generates fewer transactions than some other capital markets, and because valuations are used as a surrogate for transactions when compiling property market data and indices, the way in which valuers approach investment property valuations in practice will also influence the perceived value loss caused by any change in legislation. This latter effect is modelled in this paper. The paper identifies the likely level of change in investment yields for the major UK commercial and industrial property types, examines the current leasing structure of those properties and investigates the current application of valuation techniques to these structures. This facilitates a valuation of the commercial and industrial property investment market, from which it is estimated that the effect on the value of UK property of the upward-only rent review clause being removed from future leases would be a reduction of 5% for offices, 4% for shops and 4% for industrials, a weighted average (using IPD weights) of 4.3% across all three sectors.