Collaboration and compromise a must for landlords and tenants

17 November 2020 Consultancy.uk

Tenants, particularly those operating in the leisure and hospitality industry, will have welcomed the announcement in September confirming the Covid-19 forfeiture moratorium will now run until the end of 2020. However, according to James Liddiment, a Managing Director at Duff & Phelps, this may only be a temporary reprieve, and tenants will need to find a compromise with landlords.

The extension was no great surprise, with increasing local lockdowns and the prospect of businesses being wiped out with the September quarter day (September 29) looming and the potential for nine months of rent being payable on October 1 (when the moratorium was due to end). 

Recent data from Colliers suggests just 17% of rent due from the leisure sector at the September 2020 quarter was paid (in respect of tenancies managed by them). This figure is comparative to a blended rate of 46% being paid across all commercial classes in the same period. 

Collaboration and compromise a must for landlords and tenants

In addition to increasing local lockdowns, the transition to the Job Support Scheme plus ongoing fragility to the leisure and hospitality industry generally, the move to extend the moratorium is likely to have avoided irreparable damage, for the time being at least. While extending the moratorium to run until the turn of the year provides another two months’ reprieve, ultimately the general arrears position of the majority may worsen in the interim. Of course, risks to the hospitality and leisure industry are particularly acute, but they equally extend to retail and, to a lesser extent, other real estate asset classes. 

From the landlord’s perspective, however, the ongoing and potentially increasing arrears position leaves them in a perilous position, many unable to meet their own financial commitments leading to debt covenant breaches with lenders. The effects are being felt across the landlord spectrum from small private landlords through to publicly listed property companies.

Lenders to those landlords will rightly be nervous but continue to work with affected borrowers by providing forbearance at this time. Aside from the inevitable downward pressure on values, the key at this stage will be income preservation where landlords do not need to sell. 

Inevitable compromise

When (and if) able to do so, those landlords benefiting from optionality and financial resilience may well use forfeiture to repurpose their property. 

However, faced with prolonged void periods should tenants vacate, those landlords without such strength will need to balance the risks of re-letting, such as deciding upon what rental level and when, if ever, to include interim costs. This will all be met against a compromise with the incumbent tenant(s). 

In June 2020, the government published a Code of Practice for commercial property relationships during the Covid-19 pandemic. The Code essentially encourages parties to work collaboratively on a case-by-case basis while recognising the challenges posed by the pandemic and seeks to create an approach which is proportionate to each set of circumstances. The Code is endorsed by a number of institutions, including the Royal Institution of Chartered Surveyors. 

At its core, the Code suggests tenants which are in a position to do so should pay in full, and tenants who are unable to pay in full should be willing to pay what they reasonably can. It adds that landlords should be willing to consider renegotiating. Ultimately, however, the Code is not mandatory. 

While there is an expectation of further extension to the moratorium, or a scheme to taper/mitigate the inevitable cliff edge which many tenants will face in January 2021, there remains an opportunity for landlords and tenants to enter into collaborative dialogue to attempt to establish a compromise. 

As a best-case, landlords will be seeking to recoup the arrears in full, with agreement in some cases understood to have been reached to repay 2020 arrears during 2021 (in full or in part). However, the prospect of severely impacted businesses being able to meet the accrued arrears liability is likely to be very limited. Further, the short- to medium-term viability of those businesses may have changed to the extent that they are unable to meet their forward lease obligations, never mind the accrued arrears.

Sharing risks

One option is a move toward turnover-based rents, a route being actively pursued by tenants, both through negotiation and several well reported company voluntary arrangements since the onset of the pandemic. In agreeing to turnover rents, landlords are starting to share the operational risk with the tenant, moving away from the ‘let and leave’ culture to a more engaging collaborative relationship. 

While the transition to turnover rents is more prevalent in retail, it is cascading through hospitality and leisure. All of this will require landlords to have greater engagement with tenants. In some cases, landlords may choose to use a third-party advisor, such as Duff & Phelps, to sense check information and provide advice. 

Ultimately, as part of a turnover-based system, tenants need to be fully transparent on performance, which is unusual, and have the ability to generate prompt and robust data, particularly where they hold multi-unit estates. 

Accepting and agreeing to turnover rents is not a given. However, landlords may need the consent of their lender(s), the absence of which could mean a breach of loan facilities.

Ultimately, the pandemic has devastated many viable businesses and, moving forward, concessions and compromise will undoubtedly be required throughout the commercial real estate chain from tenants through to landlords and their lenders. What is clear is that positive outcomes will likely require constructive and collaborative dialogue between all parties to achieve a viable outturn solution as we move in to 2021.


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