There is no denying that investment landlords feel that the recent legislative changes by the Government to introduce (and now extend to the end of September) the moratorium on enforcement for non-payment of rent have dealt them an unfair hand. As Steve Norris of Soho Estates surmised in a recent Bisnow webinar on (Bankers - Investors - Tenants, Can They Maintain Relationships Through The Pandemic), some landlords are starting to feel like bankers offering free overdrafts to tenants, whether they need them or not.
Asset managers up and down the country are still working hard to bring in the June quarter rents, but the initial indications have not been positive. Mark Shipman of Mark Elliott LLP estimates that while in March their clients collected 80% of rents due, the June quarter is substantially leaner and looking more like only 40% of rents have been received. The sectors struggling most are those worst hit by the lockdown, notably retail, restaurants and hospitality. However, this quarter non-paying tenants have now started to include corporate occupiers whose sectors have been knocked by the pandemic, such as travel companies. Clearly both landlords and tenants are feeling the pain.
So how can these parties, with apparently different vested commercial interests get through this together?
Firstly, landlords that are lower geared will have the flexibility to have the necessary conversations with struggling tenants. Landlords with debt need to make sure their funders are on board with the concessions that tenants may require to ensure their survival and continued occupation, and this might in the short term mean an increase in LTV. Funders in turn will need to show flexibility towards their landlord borrowers while they navigate the sea of rent concession requests they are being faced with. Both landlords’ and funders’ interests are ultimately aligned when it comes to needing tenants to survive the economic consequences of Covid-19 and continue occupation of the assets long term.
Secondly, tenants need to show integrity and credibility. Nick Lorenz of Lorenz Consultancy is advising a number of tenants currently on re-gears required to ensure the long term survival of their businesses. At Bisnow’s seminar, he emphasised the need for the tenant to give complete and full information to their landlord when asking for a concession. The landlord needs to see where the tenant was pre-pandemic, where they are now and, crucially, their forecasts over the next period as lockdown eases. The view was that while landlords need to work with tenants to survive short term difficulties, it is of little help to anyone to grant generous concessions to tenants if they are simply going to go insolvent further down the line. Lorenz is also advising tenants to ensure that, where they can, they pay the landlord something to secure a concession, such as a rent free period being granted in return for time added onto the term of the lease.
Thirdly, landlords need to know their tenants. Where landlords know their tenants, they also know when a tenant really needs a concession and where, to put it plainly, liberties are being taken. It also helps landlord's to know their tenant’s business and understand what they bring to the landlord's asset. Steve Norris explained that there will be tenants that are struggling on the Soho Estate who they will help because that tenant’s business, their brand, their product are integral to Soho’s offering as a preeminent, “edgy” part of central London. The panel suggested that corporate or “chain” tenants owned by private equity houses which had been highly leveraged, or tenants where directors were continuing to pay themselves healthy bonuses while withholding rent payments, were also less likely to find a sympathetic ear in any attempted re-gear negotiations.
Fourthly, while landlords can and should rely on any rent deposits they hold from the tenant, it was also suggested that caution be employed in how a landlord might require a tenant to “top up” after any such draw down. Most rent deposit deeds require a “top up” within a relatively short timeframe, sometimes only a matter of weeks, and therefore if you have a tenant temporarily struggling with cash flow, this may further increase the immediate pressure on them with results that neither the landlord nor tenant desire. Instead, landlords might consider negotiating a repayment plan to “top up” the deposit over time rather than a few weeks, giving them the income from the rent deposit and the tenant the necessary breathing space. We would also separately highlight that it is currently unclear whether a landlord will be able to draw on a rent deposit if the tenant has the benefit of a moratorium under the recent Corporate Insolvency and Governance Act. The restriction on the enforcement of any security over a tenant’s property in the Act may prevent a landlord from claiming a rent deposit and whether a landlord can claim will depend on the terms on which the deposit is held and whether it is a ‘Financial Collateral Arrangement’ under the Financial Collateral Regulations 2003.
Finally, the panel considered briefly the kind of changes that they anticipate a post-Covid 19 world will bring to leasing. The overall theme was one of optimism, that London continues to be uniquely placed and will bounce back quickly as it did after the Global Financial Crisis.
Unsurprisingly, all panelists foresaw a shift in demand for office space as a result of the working from home revolution, although it was agreed that going forwards as lockdown eases, the demand will be for flexible working not homeworking, and the demand for collaborative office space will continue, particularly in the creative industries. An increased demand for flexible office space is also predicted, where the “one monthly price” modelling (including dilapidations liability) will become particularly attractive to businesses who will be watching their cash flow carefully through the recovery period. Steve Norris also predicted a change in lease term flexibility, anticipating that it is unlikely that the leases of new space entering the London market currently let on 10 and 15 year terms will be renewed on such long terms in the future. Flexibility will be the key word in a post-Covid 19 world.
Optimism was further found in the effects of the macro-economic policies that have been rolled out over the last few months. Mark Shipman highlighted that valuation yields have compressed as we head towards negative interest rates with the result that some property investments with 3-4% yields and an occupier with a strong covenant in place, are looking attractive to investors with the result that some property values in the West End are heading upwards. Landlords are also looking at alternative uses for their assets, and the Government’s recent announcements regarding relaxation of planning laws to permit certain developments without formal planning permission means we may see the repurposing of investment assets, for example, from ground floor retail to residential.
In summary, while landlord, tenants and funders have already been faced with a tsunami of challenges as a result of the Covid 19 pandemic, the waters have not yet stilled and these three sectors will need to work together over the remainder of 2020 in good faith to ensure that opportunities are created in the long term.