With a vast number of scheduled rent payments not being made on the last quarter day, many landlords’ positions are looking precarious.
There will be a large number of negotiations and discussions between landlords and their tenants around rent deferrals and holidays for tenants whose businesses may have been forced to shut down entirely for the duration of the lockdown (and possibly beyond if social distancing renders the business unviable).
There will be natural caution by landlords when they receive a request from their tenant – are they at serious risk of insolvency or taking advantage of the current climate? There are also points of principle at play around the spread of risk and associated costs between commercial enterprise and their suppliers (in this case property investors). While the law around leases are clear in this respect, a more fundamental pragmatic and commercial approach may be necessary to retaining an otherwise viable tenant with temporary disruption, than losing the tenant to the administrators and resulting void costs in a depressed market.
Below we look at some of the main issues for commercial landlords looking to protect their investments during this pandemic and resulting economic fall-out:
Short-term Support of the Rent Roll
In the landlord and tenant relationship economic risk and the success or otherwise of the tenant’s business is very much their responsibility. It is also the tenant who is likely to be taking advantage of government furlough, grants and loan schemes, off-setting their operational losses. The landlord is not currently getting any government compensation or support for reduced rental income.
However, regardless of moral hazard, by going into administration a tenant will be lumbering the landlord with no rent or service charge contributions, business rates and outstanding dilapidations to resolve. The landlord is then in an unenviable position of re-letting the space in a potentially depressed market. Against this backdrop, landlords will need to look at their investment model and potentially engage with tenants to protect their longer-term interests.
The landlord’s ability to support their tenants will vary depending on any mortgage commitments and ability to negotiate holidays from the lenders as well as what else they rely on the rental income to fund.
However, some landlords may be happier to lose the tenant if they consider that they can get a new tenant with a better covenant on agreeable terms. Ultimately it is up to each landlord to look at the bigger picture, review their investment model and set the course they feel will be to their advantage.
Protecting Value
Following any engagement with the tenant, the landlord should want to maintain the capital value, even at the expense of short-term disruption to income. Given that value of commercial investment property is primarily driven by rental income and yield, it is important for a landlord not to tie themselves into a permanently reduced income by reducing the current rental amount or re-letting in the market at a significantly lower rent and/ or to a tenant with a poorer covenant.
Capital Improvements
Investors in property with significant asset management potential may consider this an opportune time to carry out enhancements to their assets by extending or modernising the property with a view to re-letting at a premium later, particularly if the crisis has resulted in a higher vacancy rate.
It is also likely that construction costs and rental values will dip during the upcoming downturn so any capital improvement carried out during this time may ride the trough of reduced costs and re-letting in on the wave of a rising market. However, the availability and terms of financing may limit the property investors’ ability to take full advantage.
The market is likely to undergo a profound and permanent shift through this crisis with different sectors impacted in diverse ways and market demand will likely to evolve with it. Landlords would be expecting to study market trends with a view to adapting their assets to optimise their value. This can be through changing the use to meet demand in a particular sector, possibly to one less likely to be impacted by any shutdowns or altering space and amenities to meet changing tenant demands, such as additional storage/ warehousing capability or to ease the implementation of social distancing measures.
Whatever the scenario, the current crisis and economic impact will require dynamic and innovative asset management in the short- and longer-terms to mitigate the immediate disruption and position the asset to meet the future market demands.
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