Don't be banking on a rent cut

RENT REVIEWS: Nama is concerned about the impact of rent reductions on the value of the loans it took on from the banks

IT’S AN OLD-FASHIONED Mexican standoff. Retailers scream to be allowed reduce their rents in existing leases while landlords, who retailers say manipulated the rental process, argue there is no basis in the Constitution to allow such a move. The Government disagrees with the landlords, saying it can be done and has started to draw up legislation allowing it.

The National Assets Management Agency (Nama) has also waded into the debate. It wrote to then finance minister Brian Lenihan in May 2010 warning that, if downward rent reviews were allowed in existing leases, it would make the cost of raising capital higher. The net result, it said, would be that rents would have to be increased. “So in the long run, it is an inefficient measure from a national standpoint,” it said.

Nama is worried about how the legislation would impact its future performance. It bought loans from the participating banks based on what the properties were worth in November 2009 but Irish property prices have fallen by at least 10 per cent in the meantime.

That decrease was amplified when the Government parties promised during the general election campaign to look at abolishing upward-only rent reviews, retrospectively. That sent some international investors, to whom Nama was hoping to sell on the loans, scurrying for the exits, further dropping the value of Irish property.

If the legislation is passed, Nama faces a writedown of about €2 billion in its portfolio values, plus further write-offs if rents were to continue to fall. In addition, the taxpayer may have to inject additional capital into the banks to compensate for writedowns on their non-Nama loan portfolios.

Senior Liberal Democrat peer Lord Oakeshott, a former City of London financier, recently described the Irish Government's proposal as "mad". He wrote in Property Week, that someone should take it "to one side and explain in words of one syllable why that would destroy the last remnants of Ireland's banks and commercial property market".

Property sources calculated for The Irish Timesthat investment deals with a minimum value of €550 million and €600 million have fallen apart since Fine Gael and Labour said they would look at the retrospective banning of upward-only rent. Another investment deal worth €100 million is also in danger of collapse.

Nama, though, was willing to offer a variation on the legislation. It suggested that if the Government were considering changing the legislation, it could allow a tenant who had taken appropriate legal, property and financial advice the ability to opt out of the new legislation, if and when it is passed

“This would allow flexibility between landlord and tenant, so that a tenant agreeing to contract on an upward-only rent review could be offered by the landlord a lower initial rent, and/or, perhaps, rent-free periods, and indeed capital to help fit out a premises, all of which might be more beneficial to the tenant than some prospect of rent decreasing at some stage in the future based on an unknown economic cycle,” states the letter from Nama’s chief executive Brendan McDonagh and head of portfolio management John Mulcahy.

David Fitzsimons of Retail Excellence Ireland says his members feel commercial rents in Ireland are way off international benchmarks and that this was caused by a biased and opaque rent-review process. It has lobbied for retrospective rent reductions and is backing Minister for Justice Alan Shatter’s move.

He says Nama bought the loans at a discount and will face writedowns through business failures if the legislation is not changed. He says retail sales have fallen for about 40 months. He rubbishes claims by landlords that much of the reason for the fall is that customers are buying online instead.

Fitzsimons says that if rents are moved back to market levels, retailers will look at any alternative ways of calculating market rents including linking it to the consumer price index (CPI), meaning landlords would benefit in the good times and share in the suffering when times were bad through reduced income. Linking rents to the CPI is commonplace in many European countries

Others believe it is time to introduce planning status which would stipulate lower rents for classes of businesses that serve local communities such as butchers, bakers and speciality retailers in particular areas. In Dublin, this would take the form of certain secondary or tertiary streets, leaving the shopping centres and prime thoroughfares for retailers willing to run their shops as loss leaders, such as mobile phone shops, or with a retail model that allowed them to profit from their shops.

Is there anything to be learned from abroad? The answer is yes, and mainly from the Gulf States. Abu Dhabi announced a cap increase of 5 per cent on retail rents in 2009 to combat inflation. Its neighbour Dubai has introduced new rules prohibiting an increase in rents for new leases signed in 2008. However, for older leases, if the 2008 rent is more than 25 per cent below the rental index, then the landlord can impose an increase.

Some countries offer lease breaks after a specified time, usually three to seven years. This is usually subject to the retailer paying some penalty, but the major benefit for a tenant would be an ability to exit a lease where there is to be a significant upswing in its rent, ensuring the survival of the whole business is not threatened by a single major rent increase.

Meanwhile, Ann Hargaden, investment director of property adviser Lisney, has floated the idea of a Labour Relations Commision-style set-up. This would have quasi-judicial powers. Landlords and tenants would be forced to abide by its decisions. There would be power of discovery, meaning retailers would have to produce their books for the individual shop while the landlord would have to disclose any side letters they had signed that effectively reduced rents for other tenants. In such cases, Hargaden wants the headline rent to remain the same but a reduction in the rent to be allowable for a set number of years – she suggests three. At that point if the tenant could not afford the rent then part of the headline rent would only be payable if the tenant achieved certain levels of turnover.

For the moment, the Government seems set on going the retrospective legislation route. If the Supreme Court decides such a move is unconstitutional, there are more than enough innovative suggestions from here and abroad to find a solution to the current impasse.

Firms opt for ownership over lease deal

The debate on retrospectively banning upward-only rent reviews masks a key point that people are just beginning to grasp – tenants are set to become some of Nama’s biggest customers.

Google’s purchase of its existing headquarters in Dublin and the Montevetro building across the road for a combined price of €200 million will shortly be followed by Penneys’ purchase of its flagship store and overhead offices on Mary Street for €25 million. These are significant deals, particularly in the context of a moribund property market.

So why are tenants, particularly United States tenants, looking to buy real estate when for years they tried to offload it? New accountancy changes mean rent will appear on their balance sheet as a liability and, in turn, an asset of “leasehold building” will also show up on the balance sheet. Usually their values will be equal and that in itself means that owning a building is more attractive.

“Many large companies, US companies in particular, have excess cash, and property at the bottom of a bust is considered by many as a better investment than a bank or government bond,“ says Aidan Clifford, advisory services manager at the Association of Chartered Certified Accountants.

“Other changes in accounting standards planned but not yet implemented will make ownership over leasing of property in the future more beneficial for US companies.”

The interest from tenants is already there, says Peter Waller of DTZ Sherry FitzGerald, which acts for a number of multinationals looking to set up in Ireland, including business networking site LinkedIn.

“There is an opportunity now for companies to look to buy buildings they occupy on leases,” he says.