With almost the whole of the UK economy in lockdown for an uncertain period, working, shopping and entertainment patterns are undergoing a change that could last well into the future.
When the lockdown lifts, landlords and property owners will be keen to see rents and incomes return to pre-pandemic levels as quickly as possible. However, if economic and cultural changes have a major impact on how and where people work, shop and spend their leisure time, rents (and potentially lease structures) after the pandemic has lifted may bear little or no resemblance to pre-virus levels.
This will apply to new lettings as well as rent reviews and lease renewals. There will be some hotly contested rental negotiations – particularly on cases where an effective valuation date falls around or within the lockdown period. This blog considers the factors that will need to be considered in negotiations and, in the absence of agreement, how third parties are likely to approach such cases.
The Key Dates
The timeline for the Coronavirus is shown in the graph below from which it can be seen that whilst the lockdown did not take effect until 21st March 2020, the stock market started to lose confidence around 21st February 2020 - evidenced by the significant fall in the FTSE250 at that time.
The Coronavirus Pandemic and the FTSE 250
An Economic and Cultural Revolution
With almost the whole UK population staying at home (except in the case of essential services and shopping trips), huge numbers of people have been driven to remote working and virtual contact only with co-workers, friends and families.
The cost savings available to most businesses that have followed traditional lines of expensive, centralised work spaces will not be lost on business leaders. At the same time, the benefits of additional time spent at home with families and loved ones will have a corresponding impact on the UK workforce.
This period is likely to accelerate a cultural revolution that was already gathering a head of steam. The effect may not be immediate, but working practices and forms of social interaction are likely to evolve at a much greater rate – with a corresponding effect on footfall and frequency of visits to retail/leisure locations.
Rental Values during/after the pandemic
Rental value is based on the dynamics of supply (of suitable properties) and demand (from businesses willing/able to generate sufficient turnover and make a suitable profit to justify the expense of occupying a property). During the lockdown, few businesses have been signing up to new leases, in which case, demand could be said to be almost negligible.
In such circumstances it is extremely difficult to assess rental value. However, the market will return. At that time, negotiations for retail and leisure space will resume and the balance of supply/demand will produce new rental evidence. This may be broadly in line with pre-virus levels. However, if the economic and cultural changes referred to above have a material impact on consumer spending patterns, this could have a major effect on the rental levels that retailers and leisure operators are willing/able to pay.
At rent review, standard leases include the assumption of a hypothetical willing tenant. Lease renewals under the L&T Act 1954 do not specifically include a willing tenant assumption, but this is assumed from case law (Dennis & Robinson v Kiossos Establishment - 1987). The question is, with an effective valuation date within or around the lockdown period as set out on the graph above, how much rent would that willing tenant pay for the property as at that (fixed) valuation date.
This will depend on:
- what incentives landlords are offering to tenants to complete leases which had been agreed pre-virus
- how long the lockdown remains in place
- the speed of recovery of that particular retail/leisure location
If, for example, a standard incentive to complete a lease where terms had been agreed pre-pandemic is an additional three months’ rent free and a standard lease term until the tenant’s first break option is say five years, this would support a rent reduction from the previous tone in that pitch of c.5% (0.25 years over five years).
In the same way, if the lockdown ends on 21 June 2020 (three months after the lockdown commenced) and the market in a particular location bounces back relatively speedily to its pre-virus level, the “Coronavirus effect” could be limited and fairly straightforward to quantify. For example, if a standard concession in a particular retail/leisure pitch is a three month rent holiday (with no requirement to repay the rent over the following three quarters), over an assumed lease term of five years, the same 5% reduction from the previous tone would apply.
Indeed we have already seen this approach adopted in an arbitration award in Central London - and this is the approach certain retailers have adopted in negotiations on rent reviews effective from 25 March 2020.
However, if on the other hand, the lockdown was to be extended for a longer period and the market in that particular location was to take longer to recover to pre-virus levels (or find a new level), a significantly greater rental adjustment would apply.
In some locations, if supply and demand find an entirely new balance, post-virus rents may bear no relation whatsoever to the rental levels being agreed before that time.
About the author
Having worked in the Lease Advisory side for over 30 years, Matthew Hobbs is a specialist in high value retail / leisure rent reviews, lease renewals and lease negotiations.
This includes luxury shops and bars / restaurants in Central London along with other large shops (particularly supermarkets / department stores) and flagship stores for both landlords and tenants in London and throughout the UK.