The prevailing wind on the high street is one of despondency as more well-known retailers stumble into oblivion as Links of London, Bonmarché, Mothercare, Karen Millen and Mamas & Papas join an ever-lengthening list of retail failures.
The news that John Lewis made a half-year loss (and is likely to pay its partners the smallest bonus since 1954) will have sent another shudder through the beleaguered sector which has lost over 85,000 jobs in the last year, with almost 2,500 stores shutting in 2018 alone (source: PwC). Although the internet is usually cited as the principal culprit, criticism is also levelled at landlords and local authorities for levying unreasonable rents and rates. In an effort to stop a crisis on the high street becoming a catastrophe, both retailers and landlords are proposing some creative solutions in response to their respective challenges.
Landlord and tenant relationship under strain
There are have been 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 are also reviewing their rental options by agreeing to ‘lease re-gearing’ in an effort to keep shops open and trading. The landlord and tenant relationship is under considerable strain in the retail environment. Nonetheless, landlords are seeking to stabilise the position and buy some 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 often 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 as we know it is certainly undergoing fundamental change in response to the way we shop now but, to paraphrase Mark Twain, reports of its demise are an exaggeration. Smaller, independent retailers offering more niche products and services appear to be holding their own according to various reports – and it’s not just those products that can’t be bought online. Real Business (July 2019) 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”.