Guy Whitehead Explains Why Landlords And Tenants Should Start Thinking About This Now
In the current economic climate and the severe impact of Covid-19 on sections of the retail industry, the re-gearing of a lease presents an important opportunity for both landlords and tenants to re-balance their commercial objectives in order to achieve a mutually beneficial outcome. The widespread reports of tenants either withholding rental payments or seeking concessions and the continued use of creditor’s voluntary arrangements by retailers to restructure their businesses and reduce property costs, highlights the need for landlords (some of whom are proactively offering concessions to their retail tenants) to be alive to the possibility that they could have to deal with tenants being unable to resume trading when the measures introduced by the government to reduce the impact of Covid-19 have been lifted, unless they are prepared to engage with tenants and attempt to find an outcome that works for both parties.
The re-gearing of a lease should be seen as a key tool for both landlords and tenants to address any particular issues that a tenant is facing by giving tenants scope to alleviate key stress points to their business and providing landlords with comfort that they will continue to secure an income stream from the store.
The opportunity for a lease re-gear (which can be initiated at any time and for which there is no statutory framework) is often brought into focus by key events in an existing lease, such as rent reviews and tenant break options or when the market is fundamentally changed (albeit temporarily) by events such as Covid-19. These may lead to discussions as to whether the deal that was agreed when the lease was entered into still reflects the commercial reality of the market that the parties find themselves in.
In essence, re-gearing means replacing one lease with another on renegotiated terms. It involves both the landlord and the tenant agreeing to amend one or more of the fundamental terms of the existing lease and is normally achieved by either:
• entering into a new lease, which has the effect of ending the existing lease without any formal deed of surrender (although a deed of surrender can still be used if specific issues such as dilapidations need to be addressed); or
• the variation of an existing lease to amend the terms. If a longer term is agreed a reversionary lease (or one which takes effect in the future) should be used.
Re-gearing usually focusses on:
• Rent free periods which can give a tenant the breathing space it needs to continue trading.
• Reduced rents and monthly rather than quarterly payments which can assist a tenant with cashflow.
• A landlord may be prepared to offer rent free periods or reduced rents in return for extended lease terms or the removal of a tenant only option to break.
• Removal or repositioning of rent review clauses. A landlord may take the view that the removal of an upward only open market review is a price worth paying in the current market.
• Rent deposits and whether they can be returned to the tenant either in one lump sum or by staged payments by the landlord.
• Flexibility on assignment and subletting in order to give a tenant scope to potentially obtain an income stream from areas within a store which are not currently utilised.
• Capital contributions by a landlord to assist a tenant with re-fit works with a view to attracting greater footfall into a newly refurbished store.
Consideration should be given by tenants and their advisers to check whether the revised terms will mean that stamp duty land tax (SDLT) will be payable to HM Revenue & Customs if the rents payable exceed the taxable threshold.
From a landlord’s perspective, re-gearing can be seen as a chance to protect its investment in a property by securing future income streams and avoiding the prospect of costly service charge and rates voids which can be significant if the landlord is unable to quickly re-let an empty store.
For tenants, re-gearing can represent a vital method of managing costs to its business, improving cashflow and finding ways to address any particular issues that it may have with a store.
It is essential, given the uncertainty caused by Covid-19 and how long the measures introduced by the government will have to remain in place that both parties enter into discussions as soon as possible so as to avoid the situation where a tenant becomes financially distressed and ultimately has no alternative but to take advice from insolvency experts.
This article first appeared in CoStar on 7 April 2020.