The improved economic outlook has helped create some negotiating space for some landlords and tenants to do deals where they can trade off rent reductions in return for an extended lease term.
Tenants are becoming more confident, partly as a result of the economic outlook, in committing to an additional term beyond a pending break option or lease expiry. These are the views of Rosemary Casey of TWM Select, the property consultancy, who has been involved in negotiating some of these deals.
“Instead of the trench warfare that was provoked by upwards only rent reviews, now landlords and tenants are opting for a win/win approach,” she says.
Landlords naturally prefer to retain existing tenants in order to avoid gaps in income flow arising through vacancy and costs such as rates.
Where a break option or lease expiry is looming parties have the opportunity to review and improve their respective positions.
“By agreeing to a rent reduction not alone does the landlord retain the tenant for a longer period but, because the reduced rent allows the tenant’s business to become more sustainable then rental arrears are less likely to occur. Furthermore the absence of arrears and greater certainty of income for an extended term, will enhance the value of the property which will make it more attractive for an investor should a landlord wish to sell,” she adds.
For indebted landlords the improved value of the property should strengthen their negotiating position with their banks.
For tenants the win win arises because the rent reduction, combined with the prospect of increased turnover can generate hope that the business will become more profitable and thus they are becoming more confident in committing to a further three to five years on the lease
Tenants also avoid the cost of relocating or in some cases the business opportunity cost of closing a location.
“In a number of cases the tenants are negotiating the rent reductions two to three years ahead of when the break option or lease is due to expire.” Ms Casey adds.
Where the risk of a prolonged re-letting void or even vacancy is high, particularly in secondary or regional locations, locking in a tenant for an additional period, albeit at a reduced income level today, can enhance capital value.
Prospective buyers can improve their prospects of securing finance to purchase the property where the tenant’s agreement to the rental level is current and the income period has been extended. Securing a continuous cash flow over, for example, a five year term, involving the removal of a break or extending the term, adds value assuming the tenant covenant is strong.
Whilst this may involve reducing the rent to market level it does position the asset for rental growth with the benefit of security of term.
Take for example a case where the market rent is €130,000 but the passing rent is €200,000 per annum and with two years to go the landlord has secure income of €400,000. The current rental value, rental growth on the current market rent, the length of letting period and costs associated with re-letting need to be considered. The landlord who simply lets the tenant go would see gross five year cash flow total €660,000 before costs. This would consist of €400,000 in rent from the last two years of the existing lease, the loss of rent for say a nine month re-letting void and three months rent free, then an open market rent of €130,000 for a further two years.
On the other hand the landlord who re-gears the lease today, possibly even slightly above the market rent to say €140,000 per annum to allow for potential rental growth, would show secure income of €700,000 over the same five years. In addition there will be an improvement in the yield to reflect the additional security of income at a rental level more closely aligned to current rates, thus enhancing capital value.
This has already begun to happen in different markets, but especially in retail. In that sector, landlords have had to face the decision of either keeping rents at elevated levels and moving tenants on, or keeping their tenant but agreeing to cut the rent. As outlined above, the risks to both decisions is clear. However, after several landlords were stuck with an empty property because they had refused to contemplate a rent reduction, more and more of them are accepting that rents must be cut. The old adage of “jam today or jam tomorrow” remains as relevant as it always has.
Whilst funding arrangements may be keen to keep the higher rental figure this strategy will see values fall over the remaining lease term for over rented properties.
However this improved situation does not apply in every case.
It mainly pertains to retail properties as well as secondary and suburban offices which have long leases. Most of those leases have upward only rent review clauses and in some cases such clauses have led to costly and time consuming legal battles and examinerships as some retail chains tried to force rent reductions.
Indeed such examinerships deals have also been a factor in the more flexible stance adopted by landlords as they realise that when a tenant raises the prospect of examinership it may not an idle threat.
Landlords are more likely to do deals in cases where the tenants have continued to abide by the upward only existing leases as the rent reductions recognise the reality of current market rents. Shopping centre tenants whose presence is also helping to enhance the shopping mix offering are also more likely to be looked on favorably by landlords.
However landlords are less likely to accept rent reductions in the cases of prime Dublin offices as rents are rising in some of these properties in Dublin’s central business district. Indeed in some of these cases tenants would be advised to seek early negotiations on rent reviews for prime offices.
Once a commercial deal has been reached, legal advice in documenting both an increase in term and reduction in rent is necessary in order to protect both parties’ positions. Most re-gears involve deeds of variations and/or reversionary leases. An increase in the term is normally dealt with by way of reversionary or supplemental lease. A decrease in the rent may require a surrender and re-grant.
Link to Article: http://www.independent.ie/business/commercial-property/winwin-for-landlords-and-tenants-as-common-sense-comes-back-to-sector-30471907.html