We originally discussed re-gearing in December 2019 when the travails of the retail sector were making headline news. Since then, the coronavirus pandemic has turned a bad situation critical as the government instructed all non-essential retail outlets to close, in addition to pubs, bars, restaurants and coffee shops.
Laura Ashley, Cath Kidston and Debenhams (again) have joined the queue to enter administration and others, such as New Look, have announced that they are not honouring suppliers’ invoices (with an invitation to those suppliers to collect their goods if they so wish). Online retailers have not escaped either as social distancing makes warehouse work and fulfilling orders more difficult.
In an effort to stabilise increasingly strained landlord / tenant relationships, re-gearing is one of a number of initiatives that landlords have been introducing - and never has it been more welcome. Although recent government moves to halt the immediate economic fallout from the effects of the virus, by way of business rates holidays and temporary protection from eviction, are certainly more eye-catching in the short term, re-gearing is part of a long-term effort to stop a crisis on the high street becoming a catastrophe.
Landlord and tenant relationship under strain
Last year there were some high-profile examples of retail tenants using their clout to renegotiate their lease arrangements, from John Lewis threatening to withhold service charges, to H&M offering some of its landlords ‘total occupational deals’ by basing its rent, rates and service charges on individual store turnover. Landlords also started to review their rental options by agreeing to ‘lease re-gearing’ in an effort to keep shops open and trading. This will become even more urgent once the high street re-opens for business with landlords seeking to buy more time with the aid of financial incentives to encourage continued tenant presence in exchange for varying an existing lease arrangement. Such incentives could involve the tenant agreeing to remove a tenant break clause or to extend the tenant’s lease commitments by entering into a reversionary lease in return for a capital sum, a favourable rent review settlement for the tenant and / or a rent-free period, or an adjustment to the alienation / alterations provision within a lease - or a combination of all of these.
Threat of store closures prompts lease re-gearing negotiation
We have certainly seen an uptake in the number of landlords and tenants wanting to renegotiate leases. The inherent flexibility of lease re-gearing has considerable benefits for landlord and tenants alike and demonstrates a constructive approach to squaring what would otherwise be a very economically challenging circle for both retailers and property investors. Tenants are commonly negotiating much shorter lease terms now (under 5 years is now very common) and they usually include tenant break clauses. It is the threat of the tenant exercising the break clauses and closing the store that creates the leverage for the tenant to negotiate the improved terms. In the current market the threat of closure is a real one. Lease re-gearing is a practical way to help retain tenants and maintain occupancy levels, both of which are crucial if landlords are to continue:
- Securing a regular income stream;
- Increasing the asset’s capital and investment values through tenant retention;
- Ensuring the property remains attractive to potential tenants and future investors;
- Maintaining consumer footfall;
- Avoiding empty rates liability.
Such an arrangement can be equally advantageous for tenants who will certainly benefit financially from a rent-free period or nil increase rent review. Lease re-gearing also allows tenants to review their lease, which may have been agreed when rents were higher and retail profits more reliable, on more favourable terms, including the opportunity to invest in the property and / or to extend the contractual period.
Beware tax pitfalls when renegotiating lease terms
However, to avoid unintended consequences, both landlords and tenants would be strongly advised to use experienced property lawyers when renegotiating lease terms, particularly when it comes to the tax implications of any proposed changes (particularly VAT). Once a break notice is served it cannot be withdrawn so a new lease would have to be entered into if the parties reached a new deal, which would have stamp duty land tax implications for the tenant. In addition, a tenant could face penalties (including double rent under an archaic statute dating back to 1730) if it has served a break notice and has not vacated the premises when required. By involving lawyers early in the process, the lease can be restructured to minimise the tax liabilities or to ensure that a break notice can be served without any ill-effects.
Lease re-gearing is a practical response to high street woes
The high street was already undergoing fundamental change. The shutting down of the high street in March has simply accelerated that change. Depending on how long the lockdown lasts, the high street may be unrecognisable when it finally emerges – no one really knows. However, the relationship between landlord and tenant is essentially symbiotic and if this crisis prompts a coordinated and collaborative approach in future, the high street could be resuscitated. After all, shopping remains a popular pastime and that is unlikely to change much in just a few weeks.
Before the pandemic hit, smaller, independent retailers offering more niche products and services appeared to be flourishing according to various reports – and not just those products that can’t be bought online. In July 2019 Real Business reported that, as an example, wholefood shops are holding their own as more health-conscious consumers visit specialist food outlets. Although lease re-gearing won’t solve the high street’s problems at a stroke, it is one practical measure that can be deployed by landlords and tenants to keep their respective businesses on track. As one well known retailer has observed “Every little helps”.