Commercial landlords have been placed in an extremely difficult position as a result of Covid-19. While tenants have been granted protections from the government, landlords have had little assistance. With many tenants now in a precarious financial position and experiencing difficulties in paying rent, some landlords have seen a dramatic fall in their income.
What steps should commercial landlords be taking to rethink their operating model and improve cash flow?
Be flexible where necessary – but beware turnover rents
Now that a large proportion of businesses have been permitted to reopen, it’s crucial that tenants and landlords maintain a healthy, proactive dialogue and work together to come up with viable solutions to keep the cash moving and debt under control. Part of this will involve agreeing on payment plans for rent that accrued during lockdown, as well as rent owed for the next quarter. 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 to which landlords should certainly give consideration, even if it moves temporarily to an arrears basis.
More careful consideration will have to be given when turnover rents are requested, however. When it comes to retail tenants in particular, turnover rents can be a minefield of negotiation and monitoring. For example, 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.
Landlords should make sure that someone who understands the industry and the way the numbers work is involved in the drawing-up of these kinds of leases. It is only right that landlords who are willing to share downside risks with their tenants are able to share the upside as well.
Landlords will also want to carefully test the assumptions, scenarios and modelling presented to them by retailers, which may mean the inclusion of audit or review clauses by an independent third party.
The V, the U and the W
Landlords should make sure that they are prepared for all eventualities when it comes to an economic recovery. There has been much speculation as to whether this will take the form of a V shape, that is, a speedy rebound to pre-pandemic levels, or either a U or W, which would involve a more gradual improvement. Cash flow projections must be sensitised 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 also an absolute must in these fast-moving times.
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 you are working closely with your business advisers 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 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.
Your lenders are key stakeholders
With the Financial Conduct Authority clear on its expectations, banks have so far exercised forbearance in their dealings with landlords that 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. 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.
Evictions of non-paying tenants may not be an easy answer
The government’s moratorium on evictions from commercial premises and the ban on statutory demands are both set to expire at the end of September. Owners of properties in some prime locations may be reasonably confident that they will be able to find a suitable replacement if they evict their current tenant 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 medium term. 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 reputation to consider.
Outsourcing your operational model
There are steps that landlords can take to potentially reduce certain overheads and create a platform for stability during future economic shocks, whether pandemic-related or otherwise. This could include the outsourcing of your back-office finance and accounting function to advisers that have a deep understanding of the real estate sector.
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 you share with your key stakeholders and ultimately your reputation in the marketplace.
Gareth Lynton Jones is a partner in BDO’s business services and outsourcing team
