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Post-pandemic commercial leasing

23rd April 2021

Post-pandemic leasing was recently the focus of a webinar, hosted by the CTA, which attempted to provide an indication of how a commercial lease has changed since the onset of the pandemic and how it may change in the future.

The CTA’s Head of Member Services, Tony Milligan, was joined by Rosenblatt’s Head of Real Estate Disputes, Caroline Delaney, to discuss leasing solutions that may be suitable for some commercial tenants. When appropriate, the two experts also critiqued prevailing notions that have been given more weight since the pandemic impacted business operations.

Importantly, the points highlighted are not relevant to every commercial tenant. Each business is different, and some may seek to prioritise certain lease terms above others differently to businesses of certain sizes or from other industries.

Protections and guidance

The pandemic has created an economic environment that differs from previous recessions. Rather than a universal downturn in business operations, some commercial tenants have suffered excessively due to their business sector and location.

Similarly, the government has responded to the pandemic differently to how they have responded to recessions in the past. In particular, the moratoria surrounding eviction and the pursual of rent arrears offered a specific statutory safety net to tenants protecting their occupation of commercial premises.

Additionally, the introduction of the Code of Practice for commercial property relationships during the COVID-19 pandemic, was fundamental in its symbolism if nothing else. Though described as “toothless” guidance, which only encouraged communication rather than providing clear direction for landlords and tenants, the Code of Practice actively pushed for conversations to be had between potentially adversarial parties.

Post-pandemic, this notion of openness must be taken forward into every commercial lease, regardless of whether the dispute is caused by unique property problems, specific business issues, sector struggles or a global pandemic.

However, during any negotiations that modify or re-gear a current lease, it is worth remembering that a landlord will always want something in return for anything that benefits his tenant.

Watch Webinar

Even more detail was discussed in the live webinar. If you missed it, a recording can be viewed in our video library:

theCTA-call-for-evidence-post-pandemic-webinar

Key terms for a new lease

For commercial tenants seeking a new lease, the market is currently a very hospitable place to be.

Being aware of when the market is in a good or bad place is really important, and a bit of market research could set realistic expectations or could be provide a good indication of when to push for extremely beneficial and cost-saving terms.

In a tenants’ market, landlords may permit the inclusion of tenant-favouring lease clauses, rent figures, concessions and flexibility into leases that they may have previously denied at all costs. That being said, current demand in some property sectors, such as logistics, has remained buoyant throughout the pandemic and will not allow the tenant to be so forthright during negotiations.

For those businesses in sectors where the supply is high and demand low, flexibility is seen as the key benefit that all commercial tenants should be seeking, alongside lower occupancy costs and longer rent-free periods.

However, whilst a short term length may not be the primary driver in negotiations for all businesses, the ability to break a lease is an integral addition that every tenant should seek to include in a new tenancy agreement.

 

“There is a balancing act between certainty and flexibility within a lease. There is no one size fits all.”

Flexibility could also be sought in how rent is collected during the lease.

Traditionally, rent and other occupancy costs are collected quarterly, yet it may be that monthly rent payments are more preferable for a tenant’s cashflow as it would coincide with a number of other monthly bills. Indeed, it may also be preferable for the landlord.

Similarly, there is an abundance of space that has been fitted-out either by landlords or ex-tenants that new tenants can take advantage of to limit their upfront capital expenditure.

Conversely, tenants may then seek to limit their repairing covenants for the end of the lease term. These clauses are traditionally a disputed area of negotiations. Whilst full exemption from dilapidations liabilities is an extremely rare inclusion in a lease, a schedule of condition will be beneficial to a tenant and will partially limit the extent of any repairing covenants.

A photographic schedule of condition details the condition of a space prior to occupation by the tenant. It is appended to the lease as evidence of how the space should be returned to the landlord at expiry.

A schedule of condition should be undertaken by an experienced property professional. Businesses and individuals offering this service can be found in our Trusted Supplier Directory.

Different rent models

Different rent models were one of the key ideas that gained momentum during the pandemic, particularly amongst retail tenants, where there may be an inclination towards a rent linked to turnover. At the height of the pandemic, many businesses hoped to re-gear their lease along these lines whilst turnover was virtually non-existent.

Turnover rent has more commonly been used in the hotel and, occasionally, leisure sectors. However, it may be sought by landlords during negotiations for spaces where there is a captive market such as in shopping centres, stations and airports – ultimately, places where a business is likely to have a high turnover.

Whilst it would allow for lower rent during periods of low trade, turnover rent is not a magical solution for all businesses. The turnover agreement will often be combined with a base level of rent due in a hybrid format, rather than on a pure profit share basis.

Moreover, this model is definitely not suitable for all business sectors. For example, industrial units on a turnover rent agreement would effectively be charged at the (far higher) level of a retail unit.

The CTA would deter tenants from pursuing a turnover rent. The formulas for establishing turnover are numerous and the clauses are often tailored to be in the landlord’s favour, they may even result in penalties for inaccuracy.

Additionally, these agreements will require the tenant to open their books to their landlord, allowing them to scrutinise and keep a watchful eye over their tenant’s finances.

Rent levels linked to RPI

Rent levels linked to RPI could create similar concerns for tenants, where a compounded formula in the lease clause could result in extortionate rent levels after a few years.

Ultimately, despite its fluctuations, a rent level dictated by the wider property market is usually the safest approach to take when agreeing a lease.

Whilst it still seems to be a deal-breaker for 99% of commercial landlords, it may be possible for tenants to agree an open market rent review that is not ‘upwards-only’. Though extremely rare for a landlord to risk the rent level dropping, tenants are currently in an excellent negotiating position to try to demand this clause.

The CTA are constantly seeking to drive change and one of our primary frustrations are lease clauses and industry practices that have become standard despite so obviously benefitting landlords at the expense of tenants.

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