COVID-19 has placed commercial landlords in a challenging position. Whilst tenants have benefit from protections that include the ban on winding up petitions and evictions for non-payment of rent during coronavirus, landlords have had little assistance. With many tenants experiencing difficulties in paying rent, many landlords have seen dramatic drops in income.
In this article, we explore some of the actions commercial landlords should be taking to rethink their business’ operating model and improve cash flow:
Keep up a dialogue with tenants, be flexible where necessary – but beware turnover rents
As businesses are permitted to reopen, it’s crucial that tenants and landlords maintain regular conversations and collaborate to come up with viable solutions to keep the cash moving and debt under control. This might involve agreeing on payment plans for rent that has accrued during lockdown as well as rent owed for the next quarter. Hospitality, retail and leisure tenants are increasingly requesting to pay rent on a monthly, rather than quarterly, basis to help them with cash flow and this is something that landlords should entertain, even if it moves temporarily to an arrears basis.
However, more careful consideration will have to be given when turnover rents are requested. When it comes to retail tenants in particular, turnover rents can be a minefield of negotiation and monitoring. As an illustration, if your retailer tenant sells clothing online but receives returns in store, does that refund reduce the turnover of the unit? This and many other points must be clarified in the original lease otherwise the landlord could end up with funds tied up in a protracted negotiation over the semantics of the calculation. Landlords must ensure that someone who understands the industry and the way the numbers work is involved in the drawing up of these kind of leases so that these elements are clear from the beginning. It’s only fair that landlords who are willing to share downside risks with their tenants are able to share the upside as well.
Landlords will want to sensibly test the assumptions, scenarios and modelling presented to them by retailers and this may mean the inclusion of audit or review clauses by an independent third party.
Model variants on the three main forecast recoveries – the V, the U and the W
Landlords must be prepared for all eventualities when it comes to how the UK will recover. There has been much discussion as to whether this will take the form of a ‘V’ shape, that is, a speedy rebound to pre-pandemic levels or a ‘U’ or ‘W’ shape, which would involve a longer, more gradual improvement over time. Cash flow projections must account for a range of scenarios, alongside a corresponding plan or strategy to reduce nasty surprises over the coming year. Frequent re-forecasting (at least quarterly but preferably monthly) is essential in these fast moving times as the recent tightening of the lockdown situation in the North of England illustrates.
Will your retail and hospitality tenants not witness a full or sufficient recovery until everyone has returned to the office – which could be next year or even beyond? Will your food retailer tenants see a longer-term drop in footfall if people switch permanently to online grocery shopping? Make sure that you are working closely with your business advisors to leverage the financial and management information you have at your disposal to better support your decision making process. If you are lacking this information being made available to you on a timely basis, then it is time to consider how you might rectify this situation as it is a crucial factor in managing a successful business.
Evictions of non-paying tenants may not be an easy answer
The NI Executive’s moratorium on evictions from commercial premises and the ban on statutory demands have been extended to the 31st December 2020, in line with the rest of the UK. Owners of properties in prime locations may have confidence that they will be able to find a suitable replacement if they evict their current tenant for non-payment of rent once the ban expires. For others, this is much less certain.
Landlords will need to consider the impact on their finances in the short to mid-term before they decide to evict a tenant. For example, would it be better to receive a lower amount of rent guaranteed over a set period, rather than risk having an empty unit that generates zero income during what could be a protracted period of economic uncertainty? It may be that the devil you know is better for your cash flow. There may also be a longer term impact on your reputation to consider.
Your lenders are a key stakeholder – manage that relationship closely
With the FCA clear on its expectations, banks have so far exercised forbearance in their dealings with landlords who have been unable to meet deadlines for loan repayments due to tenants not paying rent.
However, some non-bank lenders, such as overseas investors, may not be under the same restrictions in how they request payment from borrowers. As a result, these lenders may not be as flexible over loan covenants. Landlords should ensure that they are in regular contact with their lenders and give them plenty of notice if they require flexibility, which may mean short term adjustments to covenant targets. Just as you want your tenants to give you a clear picture of where they stand on rent payments, your lenders will want the same from you when it comes to servicing your debt.
Could an outsourced operational model offer more resilience and an ability to tap into a well of industry expertise?
There are steps that landlords can take to potentially reduce certain overheads and create a platform for stability for future economic shocks, whether COVID-19 related or otherwise. This could include the outsourcing of your back-office finance and accounting function to advisors that have a deep understanding of the real estate sector – not only giving you access to third party knowledge and experience as a trusted partner and strategic sounding board, but more importantly, freeing up internal resource to focus on the day to day running of your business.
Would you benefit from being able to reallocate resource to the pressing concerns of the day, such as talking and collaborating with your tenants and investors? This reallocation of resources could have a significant positive impact on the amount of cash you are able to generate, the relationships that you share with your key stakeholders and ultimately your reputation in the market place.