‘The model is broken’: solving the leasing question

Throughout lockdown, it has been easy to cast commercial landlords as the big bad wolf.

From this perspective, property owners are wilfully sticking their heads in the sand, demanding operators stump up payment, regardless of their sudden and total lack of revenue.

Yet despite some notable bogeymen, Asif Aziz’s Criterion Capital one example, the real picture has been more nuanced.

Institutional landlords, who have artfully curated their estates and food and beverage operators, have been understandably supportive, mindful that their mutual success and futures are intertwined.

West End landlord Shaftesbury says it expects to be supporting tenants right through the recovery amid a sharp drop-off in rent payments.

CEO Brian Bickell went so far as to tell the Financial Times that the traditional leasing model was “falling apart”, explaining that its 800 occupants would be moved from quarterly to monthly payments.

The upheaval of the virus and lockdown has led to all sorts of rethinking of how leasing could work, with turnover rents and partnerships in the mix.

Upward only rent reviews and deposits are other cash burdens operators would no doubt like to see revised.

David Abramson’s Cedar Dean Leisure has been involved in leasing restructuring for some 12 years, and says the current system “could not get any worse”.

“Quite simply, the model is broken,” he tells MCA.

The key factor here for Abramson is upward only rent reviews, which he says are forcing companies into an insolvency or CVA process, as the last resort to shake off onerous leases.

Of course, this is nothing new, with rents especially in London widely seen as unsustainable for the last five or six years.

But like in many other areas, the coronavirus is providing a stimulus to deal with the issue, and fast-tracking the pace at which this happens, Abramson says.

He believes the alternative of ignoring the problem will be much worse for the landlords in the long run.

“Basically, the whole market just needs a seismic reset on valuation, yields, capital values,” he says.

“Landlords are hoping the worst might not happen, and so are avoiding proactive discussions. That is leading to a lot of businesses having a top four accountancy firm come in to create CVA processes, which forces the hand of these landlords to get a much worse deal then they probably would have got by direct negotiation.

“CVAs are punishing for landlords, especially at the moment. But landlords are not being proactive enough, or thinking long term.”

Another key piece of the leasing model up for discussion are deposits.

Ted Schama, managing partner at Shelley Sandzer, says while landlords are not immune to the crisis, and will resist giving away too much ground on deposits, tenants ultimately have more to gain.

“I do believe this time, tenants will gain more in their favour resisting deposits, certainly getting them down to a maximum of three months, or negating them as much as they can”, he says.

The trade-off for operators of a reduced deposit will be more scrutiny from landlords about how sustainably they trade.

Going further down this path, in the US asset managers are adopting a much more hands on approach to property, something Schama suggests could gain traction here too.

Under this model, landlords pay for the fit-outs, and even own a major stake in the operator business.

The operator then pays back the landlord when they reach a certain threshold of turnover, and the ownership flips back in their favour.

“It won’t be a question of the landlord dictating to the operator, but the landlord will demand to see results, or certainly having a bottom level of performance,” Schama explains.

Rob Meadows, executive director at Davis Coffer Lyons, is sceptical about the wisdom of landlords getting too closely involved in operating, and funding fit-outs for example.

“When you look at trying to amortise or recoup that investment as a landlord, it’s quite a tricky calculation, and I think both parties might get too  involved in the other part of the business,” he says.

“I think it can become quite complicated when you’re giving money and packages away like that. It is very straightforward with the old leasing model.”

More cautious in his assessment, Meadows says it is too early to say how the landscape will look with lockdown still in effect, though restrictions will be eased by 4 July.

With turnover rents another suggested solution, he does not believe they are what good operators really want, that is to share their upside with landlords.

“The soundbites are punchy, but the reality is that no one knows,” he says. “It’s quite hard to put a finger on how things are going to pan out in four years.”

Operators want security of tenure, and control over what they can and cannot do with a premises, he adds.

“Historically, the thinking is ‘I’m happy to pay the best rent here, because I know that I will trade at a higher level than the guy next door and that money is in my pocket, rather paid as a turnover.’”

Ultimately, Meadows does acknowledge leasing will change, albeit pointing out the issues with alternative models.

“I think potentially we will see different rent review mechanisms, maybe different rents and styles of paying and more turnovers,” he says.

Another trend is shorter lease terms, which Meadows says are not in the interest of good operators.

“If you are successful you want a long lease, but lease terms are being eroded because landlords are giving so much more than they used to, and focusing on operational control of the building or area in the medium term.”

The risk of turnover-oriented rents could be a high street filled with units of the lowest common dominator, where landlords prize low-risk revenue over community value.

“You end up with the cheapest, highest margin tenant, like a tourist tat shop, which is not helpful for the area, but is what you see in those big pumped peak prices in Leicester Square for example.”

Abramson at Cedar Dean is equally sceptical of turnover rents, for similar reasons, though suggests they could be a temporary solution as the sector recovers.

“Longer term, rents just need to be much lower and affordable and not such a bind on businesses,” he says. “Then you can actually keep the sort of securitisation and capital markets going.

“It’ll be very hard for banks to fund landlords based on turnover rents because it’s very unpredictable. But if rents are lower and sustainable, then that whole model could continue.”

Much pain lies ahead though, Abramson warns, with even the most influential operators unable to control their own destiny, due to the manifold uncertainties created by the virus.

“Business owners need to know what they want,” he says. “But in reality, it’s very hard for business owners to know what they want, post lockdown, because they don’t know what new trading is going to look like, or what customer behaviour is going to look like.

“That’s why so many people are talking about turnover rent, though I don’t think long term it’s what anybody really wants.”

Schama takes the conversation back to a more fundamental concept: relevance.

While the likes of The Restaurant Group regret Frankie & Benny’s onerous leases, it is the brand’s failure to evolve in recent years that has left it in such a mess, he says.

And the major listed landlords have been supportive of tenants, particularly to the smaller lesser established operators. The irony is that it’s the biggest brands, which once had the best covenants, which are now often the ones in most trouble, says Schama.

This will be a key question for landlords when considering if an occupant is worthy of assistance, he suggests.

“If a business hasn’t changed in a decade, and is already on the brink of a disaster, already on the cliff edge, can you really justify assistance?

“From a human point of view, of course I feel sorry for the people involved. But from a purely business point of view, those types of businesses will be the first to tumble. And we all know why. It’s not a landlord and tenant issue.”