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FRS 102 Rent Free Period and inflation

Spreading of rent free period where there is also future inflation linked increase

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Hi all,

Business has a few rental agreements in place which are subject to incentives, these being rent free periods.  On looking at the contracts, there is a rent review period which will allow for an initial increase in rental value, either based on open market or inflation rates, and then again each year following to the end of the lease.  It is highly likely that the business will continue with the lease following the rent review and so would be subject to any increase.  When working out what the average lease cost should be, does the possible increase in rent need to be considered, or would these just be taken though the P&L as and when they occur?   

Thanks in advance.

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Hallerud at Easter
By DJKL
03rd Feb 2020 10:48

1. Annual rent reviews- very uncommon, are you sure>
2. Does tenant have right not to carry on at any of these future dates-break clauses.

I frankly would ignore until they arise, you have no idea what either inflation or open market rent may be in the future, for all you know RPI or whatever other metric per lease will be negative (though suspect upward only review so if that were the case and market rents were flat/negative the rent would stay the same)

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By johnt27
03rd Feb 2020 12:03

The lease incentive should be spread over the life of the lease, unless the directors are reasonably certain the lease will either be shorter (or longer), based on current expectations.

More often than not incentives are reasonably straight forward ie 6 months rent free at commencement and it's unusual for these to be index linked or linked to future rentals. If it is you have a discounting problem to consider too - again based on reasonable expectations.

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By kjones1986
03rd Feb 2020 14:25

Thank you both for your responses.

Have managed to get my hands on the amended contract for this which references that there is only one rent review which will occur in November 2022, this will then reset the annual cost until the end of the term in 2027.

The contract states that either a Indexed Rent Review will take place or an open market review will occur. On the former it gives the RPI period and data set that would be used (assuming these don't change between now and then), it also has the following points.

R = A x (C/B)

(a) if the indexed rent calculated pursuant to paragraph 2.2 is less than the product of the formula A (as defined in para 2.2) x 1.082 then the indexed rent for that review period shall be the product of the formula A x 1.082; or

(b) if the indexed rent calculated pursuant to paragraph 2.2 is greater than the product of the formula A (as defined in para 2.2) x 1.169 then the indexed rent for that review period shall be the product of the formula A x 1.169.

Formula A is the Annual Rent payable on the date immediately prior to the Review Date (ignoring any suspension or abatement of Annual Rent pursuant to the terms of the lease).

B = Index for the month immediately preceding the term commencement date
C = Index for the month immediately preceding the Review Date
R = Indexed Rent

Based on this should the FRS 102 spread allow for the the 1.082 increased to rent as this would be the minimum that would be seen applied to the rent from 2022?

There is nothing I can see which will determine if a Index or Open market review will be taken.

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Replying to kjones1986:
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By johnt27
03rd Feb 2020 14:44

I think you're confusing the rent renewal cost with the lease incentive unless I'm mistaken.

What are the terms of the lease incentive?

Is it, for example, 6 months rent free or is it tied into the renewal ie 3 months free at commencement of lease and 3 months free on rent review?

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Replying to johnt27:
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By kjones1986
03rd Feb 2020 15:17

Document signed in October 18 with payment beginning August 2019, review in 2022 which will be subject to a uplift (index or market), with the lease ending in 2027? My understanding was the average lease cost would be spread over the period October 18 until October 27? Just not sure on the treatment of the review process and if that should be considered in arriving at the average rate? thanks

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Replying to kjones1986:
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By johnt27
03rd Feb 2020 15:37

Edited for terrible maths!

So the lease incentive is the period between the first rent charge period (presumably October 18) and when the payments commence (assuming that's the full rental amount) in August 19.

So 10*£xxxx (being monthly rent not paid) is your lease incentive, which is then spread evenly over the lease term to October 27 as you've stated.

Just because the lease payment is under review during the lease term makes no odds unless that's tied into the incentives which it doesn't appear to be.

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Replying to kjones1986:
Hallerud at Easter
By DJKL
03rd Feb 2020 15:35

If you have minimum sums certain post the rent review I would use them when calculating the allocation over the eight years.

So
2018/2019 Yr 1 0
2019/2020 Yr2 £20000
2020/2021 Yr 3 £20000
2021/2022 Yr4 £20000
2022/2023 Yr 5 £21600
2023/2024 Yr6 £21600
2024/2025 yr7 £21,600
2025/2027 Yr8 £21,600

Average annual 146,400/8 =£18,300

So if there is a minimum at review re uplift slot it in, if not then 7x2000=£140,000
Average £17,500
(All figures made up)

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Replying to DJKL:
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By johnt27
03rd Feb 2020 15:57

The year 1 lease incentive in your example is £20k!

The P&L lease charge in yr 1 would be £17,500 (being £20k less £20k/8)
Every additional year has rent paid reduced by £2,500 (being £20k/8) as a lease incentive release resulting in P&L charge.

I like the maths but it's wrong and doesn't comply with FRS 102. Not material in this case but could be with lots of leases or bigger numbers. The only time this is permitted is if the inflationary increases are reflected annually in the lease document which is very unlikely in the UK.

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Replying to johnt27:
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By kjones1986
03rd Feb 2020 22:11

Thank you both for your responses on this.

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