Landlords and tenants must work together in the face of coronavirus

Unprecedented threat to investments and businesses

For a commercial landlord, investing in real estate is all about the income return and the associated risk. Photograph: Getty Images

For a commercial landlord, investing in real estate is all about the income return and the associated risk. Photograph: Getty Images

 

We are living through unprecedented times. In effect cash flow has stopped for most sectors of the economy. In general in times like this, there is a dip, a trough and a recovery. In this case the dip has been immediate, the trough is uncertain but will last a number of months and for most the recovery is likely to be relatively quick as there will be a push to get back to business globally.

Landlords and tenants will be keen to get through this while protecting their investments and businesses. This can happen in a fair and balanced way. With this in mind it is useful to look at the processes landlords and tenants can use to navigate difficult economic times together.

Landlords’ perspective – protecting the investment

For a commercial landlord, investing in real estate is all about the income return and the associated risk. Apart from location, the risk involves the strength of the tenants, the level and sustainability of rent being paid and the length of lease. The most valuable commodity is a long-term lease to a blue-chip tenant paying a market/sustainable rent in a prime location.

Landlords spend significant amounts of capital in acquiring assets based on calculated risks. Among other matters, these calculations are based on the financial strength of the tenant and the lease agreement under which they occupy the asset.

Leases generally contain conditions around payment of rent, insurance and service charge, interest on late payment, keep open clauses in shopping centres, forfeiture for non-payment etc. Therefore when assessing options commercial landlords will revert to analysing the ability of the tenant to pay and the legal agreements in place.

The landlord will want to be fair but will need to be sure that any decisions are fully justified and protect the investment and the interests of their other stakeholders. They will also want to be sure that in return they are treated fairly by their tenant.

In the current economic situation some sectors will be more risky than others for example hospitality, non-convenience retailing, airline industry etc. Some sectors will be resilient such as supermarkets, healthcare, takeaway etc and therefore when assessing the ongoing investment landlords will have regard to the sector in which the tenant operates.

In deciding on their options, commercial landlords will firstly seek to assess the ability of the tenant to honour the terms of the lease. For example, if a business has been forced to shut down or cease operations for a period or if business is continuing remotely, albeit at lower turnover levels.

Flexibility may be possible if a tenant under pressure can demonstrate that the issues are as a result of the current pandemic and where value can be protected by ensuring the sustainability of rent in the future and a longer more secure income stream. This can involve rent-free periods or reduced rents in return for increased lease lengths and/or guaranteed future payments.

The commercial tenant ’s perspective – inability to pay

In this instance the landlord will assess if the need is real by reviewing the business sector and the tenant’s business. For example, the tenant’s business may have been forced to close and there is no turnover. If the need is proven there is likely to be more flexibility where the landlord is an institution or landlord with no debt. These landlords are likely to be more concerned with protecting value and the longer-term impact than the short-term cash flow impact, although their shareholders/unit holders will still require a return.

They may be able to forfeit a return now for a value uplift later if the business case can be proven. In these cases the landlord may agree to a rent reduction or rent-free period in return for this being paid back over a few years or agreeing to fixed rent uplift in the future or indeed a longer lease term, where the lease is expiring in the short term. The tenant may be able to offer further lease guarantees for the future.

Where the landlord has debt in place, their flexibility will be driven by what their bank will accept. The bank will not want a borrower forced into arrears or worse. Therefore, the bank may agree to a repayment holiday in exchange for adding this amount to the loan or increasing repayments when the crisis is over. The landlord can then pass on this flexibility to the tenant.

Service charges

There has been some talk that tenants might not pay service charges. This is something that is not in anyone’s interest. The service charge is purely for the upkeep and ongoing operation of the building services.

In some instances where these services have been reduced, for example shopping centres, then the ongoing cost may be reduced. Essential services such as maintenance and security will however need to be maintained. Some service charges include building insurance so it is important that this is maintained. With all parties pulling together at this time maintaining services will be important to ensure that when the crisis is over all can get back to normal as quickly as possible.

One issue for commercial tenants are rents that are inclusive of outgoings. It will be important that tenants acknowledge the necessity to pay these for services, rates and insurance. Rates relief is something that local authorities may address to help businesses.

Overall, it is in the interests of all involved in the market to ensure as many as possible get through this difficult period. Because the trough is likely to be relatively short, agreements can and should be reached where the differing requirements and interests are respected. It appears from actions taken thus far by the Government, banks and property bodies that getting through this short-term blip with as many surviving as possible will be the overriding objective. If the crisis continues in the longer term, flexibility will be more difficult and the solution will come down to a matter of supply and demand.

Seán O'Neill is a director at commercial property adviser TWM