The squeeze on commercial landlords
July 20, 2020
Sharing the pain
The government has taken the stance from the beginning of the coronavirus outbreak that where possible, the landlord should share some of the pain being experienced by tenants. In its latest new code of practice for commercial landlords and tenants the government acknowledges that landlords should provide support to businesses if they are able to do so. Its objective has been to provide the right support to those in the chain of commercial property payments, from customer, to tenant business, to commercial landlords and lenders, to enable a swift recovery.
To date, this has meant suspending tenant evictions by enacting a moratorium on forfeitures; changes to Commercial Rent Arrears Recovery (CRAR), preventing statutory demands and winding up petitions for businesses affected by the coronavirus; and associated measures for tenant businesses including making available grants, guaranteed loans, business rate relief, and the job retention scheme.
Nevertheless, the government has been clear that tenants who are able to pay their rent in full should continue to do so, whilst those businesses that cannot pay in full should communicate with their landlord and pay what they can. The overall aim has been to provide tenant businesses the breathing space to work with landlords and other partners on a plan for a sustainable future.
What about the contract?
Generally, landlords and tenants have acted reasonably, partly because they have a mutual interest in business continuity that reaches far beyond the extent of this pandemic. They are economic partners, not opponents. Across all sectors, we have already seen landlords offering rent holidays, deferrals, and reductions where possible, which is encouraging.
However, some commercial landlords have felt that they have had to bear an unfair proportion of the financial hardship, particularly because the lease is a legal contract with their tenant, which under all normal circumstances would compel the tenant to pay the rent (and of course still do once the temporary measures expire). They point out that like tenants, many landlords are also experiencing significant cash flow problems and have their own financial obligations to meet.
Some landlords might not have any choice but to take action, particularly if they are unable to service the interest on their loan agreements. A number of landlords are also frustrated that some tenants in the stronger performing sectors are not paying their rent and that the usual remedies are not available to them to deal with this. Landlords must also make a return on the investment and risks that they have taken. There have been calls for financial support to commercial property landlords, but no response has been forthcoming.
Landlords need to check mortgage deeds and communicate with their lenders to avoid breach of their obligations which could lead to penalty interest rates, costs or other repercussions.
Nowhere has the hardship been more transparent than in the retail and hospitality sector. On 26th June shopping centre owner intu entered administration. With 14 wholly owned centres and three joint ventures, intu is the UK’s largest shopping centre owner. This hardship is also reflected in rent payments where only 40% of retail rents were paid in the March quarter and early indications suggest that the level will be similar for the June quarter.
As the economy recovers, rent payments will pick up, but many companies will also go out of business. We expect there will be more pressure to come on landlords and believe that it is likely to negatively affect vacancy rates, rental values, and lease terms over the next six to twelve months.
Institutional investors under pressure
We remain impartial and try to present a balanced picture but appreciate that for many people the landlord is often viewed unsympathetically. As this week’s Economist pointed out: “most people probably have more sympathy for chefs and waiters than for landlords.” However, what many do not realise is that payments made to commercial landlords are increasingly channelled towards the pensions and insurance industries. The global stock of investible commercial property has quadrupled since 2000, to US$32 trillion, of which more than a third is owned by institutional investors.
Moreover, much of this investment has been financed by debt. This means that much of the resulting lost rental income is likely to have passed through to missed debt and mortgage payments. This is still not wholly visible because many banks report losses with a lag and with limited detail, but it can be seen in the delinquency rates on commercial-mortgage-backed securities (CMBS) which have risen sharply. Furthermore, investors in the UK commercial property market are reportedly facing £43bn of commercial property refinancing in 2020-21.
At present, assessing the extent of potential losses for commercial landlords from the crisis is difficult and working out who will bear those losses is even harder. This is not helped by the fact that listed property funds have currently suspended redemptions because of the material uncertainty of the value of their assets. This has reportedly restricted activity of some £12.8bn of assets inside listed UK property funds.
Some options in negotiation
Landlords and tenants have experienced a novel situation, and many are being creative in their approach to the situation. Some routes being taken include:
- Rent reduction. Some tenants whose doors are shut and have large-scale businesses have demanded cancellation or reductions in the monthly or quarterly rent to a sustainable level. Some landlords have taken the long view and agreed to this or compromised, others have not.
- Delaying payment of rent. This provides short term relief but is only a long-term solution if the tenant’s business can cover the rent later on. Defraying the rent over the remaining period of the lease or over the next 2 or 3 years may work well for both parties.
- Landlords have waived contractual default interest on unpaid rents or rents paid in arrears.
- The tenant borrows to pay the rent. Many landlords say that as there are government supported schemes to take out loans that this is how the rent should be paid. This puts the burden on the tenant alone and could lead to business failure down the line.
- The rent is varied to reflect the turnover or profit a business receives. This shares the burden between landlord and tenant but has not been well received by landlords except where there is potential for a significant upside in the future or the landlord does not see a better option.
- Where there is a rent deposit some tenants have proposed that is used to cover the rent. Rent deposit deeds usually contain a provision under which the tenant can be pursued to top up (replenish) the deposit, so using the deposit may only delay legal action. A tenant in difficulties may try to negotiate that a future top up the deposit is not required. Some landlords have been reluctant to accept this step as they still want to retain the security of the deposit.
- Landlords are agreeing to reduce rent payments in return for renegotiating other provisions such as personal guarantees, the removal of break clauses, or extensions to the existing lease.
- Where landlords need to collect rent or want to regain possession of the property, some are pushing tenants hard - using the landlord’s remedies that are still available as set out below.
Landlords and tenants should take care when using words such as “rent holiday”. Some people think this means no rent is payable at all for the instalment or until further notice, whereas some people think it simply means a delay in paying rent. Any agreement that changes obligations in a lease should be properly recorded to ensure clarity and avoid litigation once the temporary measures are lifted.
A recent survey of retailers and their landlords by Savills looking at how leases were expected to change over this year found that 49% of leases would likely be unaffected, 24% were likely to have a rent-free window, 22% were likely to have a rent reduction, and 7% will likely move to a turnover base rent.
Depending on the circumstances, there are still some remedies for commercial landlords at the moment. However, they are limited, and we have not come across any easy solution for landlords to pursue rent from tenants. Also, it is likely that pursuing coronavirus-related disputes in the coming months, while we are still coming out of lockdown, risks at least some damage to their reputation and possibly some form of regulatory intervention.
As it currently stands, the UK government has extended the Coronavirus Act measures to prevent struggling companies from forfeiture from 30th June until 30th September 2020. This means that a landlord will not be able to forfeit (terminate) a tenant’s lease if they fail to pay their rent in the next 3 months. During this period, the government will prevent landlords using CRAR, unless they are owed 189 days of unpaid rent.
This means that landlords will only be able to take action and serve a CRAR notice at the end of September to tenants who did not pay the 2020 March quarterly rent and decide not to pay the 2020 June quarterly rent, because the 189-day period would have expired.
Some landlords are looking to regain possession. Some landlords are looking for ways to put pressure on the tenant, so the landlord is higher up the list when the tenant working out who to pay with scarce resources. Some other approaches to apply pressure on tenants include:
- Initiating court proceedings for a money judgment (CCJ). Though slower, this is one of the very few rent collection methods still open to landlords. Most commercial leases allow landlords to recover the costs incurred in a debt claim, though some landlords are holding off taking action if they fear that once they have incurred the court fee and legal costs that the tenant may become insolvent.
- Making a claim for the rent against a guarantor or subtenant. Landlords are free to pursue a guarantor in respect of a tenant's breach, subject to the terms of any guarantee.
- Issuing a rent diversion notice. If a tenant is not paying rent but a subtenant is, a landlord can serve a notice that a subtenant pays rent direct to the landlord, missing out the tenant.
- Initiating forfeiture actions for other reasons. The coronavirus legislation does not prevent landlords serving s146 notices for breach of other provisions of the lease or other documents such as a licence to alter. Landlords looking to regain possession or put pressure on the tenant have been known to inspect premises and investigate possible breaches that can be used to encourage rent to be paid such as repair, decoration, subletting or user obligations. During a lease an interim schedule of dilapidations can be served if the lease allows. If there are dilapidations and the lease contains a Jervis v Harris clause, the landlord can use this clause to threaten to carry out works to the property and claim the cost of those works from the tenant as a debt action.
- Landlords are reviewing the borrowing position of the tenants to ascertain whether pressure can be applied in this way. Receipt of a demand (or Statutory Demand) might trigger a default in a debtor's facility documentation or commercial contracts.
- Before coronavirus, landlords frequently used insolvency remedies to encourage payment of rent. The government has largely prevented this for the time being, however, some landlords are investigating whether pressure can be applied in this way. If a company has not been financially adversely affected by coronavirus or the company’s inability to pay was not caused by the COVID-19 pandemic it is possible in the right circumstances that a winding up petition may still be served. In a recent case a winding up petition where insolvency was established pre-coronavirus was allowed to proceed.
- It has been argued that whilst there are restrictions on serving statutory demands and commencing winding-up proceedings, there are no such restrictions on applying to the court as an unsecured creditor for the appointment of an administrator. This will, however, be a costly process and one that may not be commercially viable, particularly where the landlord's debt will rank behind that owed to any secured creditors.
- Subject to the terms of the policy, landlords may be able to make a claim against their insurance for any business interruption.
- A small number of leases have a break right that the landlord can exercise. The legislation does not prevent this.
The Situation is Evolving
Government has suggested that employees should not use public transport unless absolutely necessary, and that if they can work from home they should. This leaves little or no incentive for London office workers to return to their desks. Many have made the decision to keep offices closed, some until September, others including the City of London until January 2021. The tone of the government though is now changing.
As a result, there does appear to be a real change in the feeling in Central London. There are a lot more people on the streets and the pubs and restaurants are opening again. Some people have started coming into London again, if only a few days a week, and they will probably continue to do so until they feel the need to come in more often.
This is not the end of the traditional office, but the working environment will evolve. There is likely to be a mix of those who will be in the majority of the time, as either they want to or their job demands it, and those who use the office only as and when needed. Employers are going to have to re-think how they employ their office space and how much they require. This is only likely to increase the squeeze.
This note does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by Elliott Matthew Ltd.
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