Variable is the New Desirable: Commercial tenants want to share COVID-19 financial burden with landlords

August 7, 2020

3 min read

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What's going on here?

As retailers struggle to pay rent in the face of persisting financial difficulties, many are calling for landlords to share their financial burden by embracing a shift to variable leases.

What does this mean?

Most commercial tenants have experienced a collapse in profits due to the lockdown. Even now business premises have started to reopen, limits on the number of customers permitted inside stores and increased cleaning costs have made it harder for tenants to meet rent payments. The liquidity of commercial tenants is also threatened by the risk of localised lockdowns going forward.

In the face of this hardship, retailers of all sizes have sought heavy rent reductions. Some retailers including Primark and Burger King have even been withholding rent payments, which could spell the end for businesses that act primarily as commercial landlords. Accordingly, Intu, which owns the UK’s largest shopping centre, fell into administration after receiving just 29% of the rent it was owed in Q2 2020. With landlords reliant on struggling retailers’ rent money, Urban Outfitters and Levi Strauss (amongst others) have suggested a compromise; variable leases. 

Variable leases link store performance and business profitability to rental rates which seems the perfect compromise. Although Legal & General (another of the UK’s biggest retail landlords) recently adopted this type of leasing structure, many landlords might resist attempts to rewrite lease agreements. This is because it would introduce risk into commercial property investments, which have historically represented consistent revenue, as rent would fluctuate according to factors outside of landlords’ control.

What's the big picture effect?

Landlords and tenants’ interests are often in direct conflict which can make for difficult commercial relationships. This makes variable leases, which rely on transparency, exceedingly complicated. One challenge is online sales. Although a physical store in a high footfall area increases the retailer’s brand-value, it is unclear how much of its revenue is attributable to the physical store. This challenge, amongst others, is something that has hampered the French retail industry since April 2020 when executives from over one hundred retailers wrote an open letter urging landlords to link rent rates to revenue. Despite these pleas and even French government intervention, a compromise could not be reached.

On this side of the English Channel, however, landlords might be forced to concede. This is because the measures introduced by the UK government to protect commercial tenants have consequently limited landlords’ powers. Some of these measures include a suspension of Commercial Rent Arrears Recovery, which previously allowed landlords to seize a tenant’s assets and sell them to recover arrears; as well as the prevention of forfeiture (bringing a lease to an end) for non-payment of rent. As a result of this weakened position, landlords might consider lease alterations beneficial to receiving nothing should tenants withhold rent or go insolvent.

Variable leases becoming the norm will worry traditional landlords and investors, but the momentum is in that direction. A survey conducted by property consultancy Colliers, found that 40% of UK landlords would be more likely to factor turnover, footfall and online sales into lease agreements going forward. Considering the shift to online shopping has undermined the economics of physical stores, this modern innovation in property law could be a lifeline for the threatened industry.

Report written by Keir Galloway Throssell

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