The Power Balance Is Shifting in London’s Commercial Real Estate

LONDON – For years, landlords have had the upper hand in the London property market, increasing rents as businesses demanded prime locations near offices, tourist hotspots and transportation hubs, and the city’s population grew and grew. Restaurants were often linked with clauses that only allowed the rent to be increased. Retailers were increasingly faced with exorbitant rents.

Over the course of a year, the pandemic brought this regulation to a standstill and shifted the balance of power between tenants and landlords of commercial properties.

Given the alternative of having empty properties, some landlords have eased their terms by offering vacation rentals or other concessions. In other cases, however, changes have been forced on owners by tenants in difficulty who have increasingly turned to an option in UK bankruptcy law known as a voluntary corporate arrangement. The result was reduced rents or a switch to rental contracts, which fluctuated depending on the income of the tenant.

Given the dwindling outlook, some property owners say the leasing system is out of date and are calling for more transparency and collaboration with their tenants. And an upcoming legal review by the UK government could bring further changes.

The relationship between tenants and landlords “has definitely grown strained with the pandemic,” said David Abramson, founder and chief executive officer of Cedar Dean, who specializes in helping businesses restructure lease agreements. “Landlords are not used to doing business with one hand behind their backs. In general, they were the dominant force, and it was pretty aggressive. “

Landlords had to have “a complete change of attitude,” said Mr Abramson. “Many of them still have it in their heads.”

Changes are slow to happen, especially for small businesses. Dhruv Mittal, a 29-year-old chef, made a heartbreaking decision last summer: he closed his restaurant in central London’s Soho district after lockdowns made it impossible to continue.

He had opened DUM Biryani House restaurant four years earlier in a basement room with pop-art-inspired posters on the walls, pumped out hip-hop music and served biryanis in the traditional style of Hyderabad in south-central India, where his father is from.

Despite government measures to help the business survive the pandemic, the quarterly rent for Mr Mittal’s restaurant, about £ 20,000 ($ 28,000), proved to be an insurmountable burden with no revenue coming in. He tried to move to a smaller location, but his landlord’s company had nothing and negotiations to reduce his rent were unsuccessful.

“Our landlords were pretty much convinced that they would prefer an empty location where they could charge a newcomer the rent they wanted instead of giving the current tenant a discount,” Mittal said.

In August, the landlord made an offer: Mr Mittal could postpone payment of a quarter of the rent – the amount he owed – until 2021. By then, however, he had laid off his staff and could not reopen as the center of London was still left. In October he liquidated his company and still owed other creditors tens of thousands of pounds in rent and money.

The property has no new tenant yet; The sign of the DUM Biryani House hangs over the closed doors. The landlord declined to comment.

Mr. Mittal would not have been evicted immediately because he had not paid his rent. Last year the government imposed a moratorium on the eviction of business tenants, which was extended to the end of March. Many companies have made use of this rule, but most unpaid rents will only accumulate as debts that can be claimed once the ban is lifted.

A more contagious strain of coronavirus and, in some cases, a winter flood have closed UK restaurants and shops again. By the time many of these companies are allowed to reopen, their doors will have been closed for at least half of last year. A recent survey found that only about half of retail rents were collected in the last three months of 2020.

Many tenants urgently need more help. Cedar Dean surveyed 400 leading hotel companies last month, and three-quarters said they were considering restructuring or bankruptcy and would either need help from the government or their landlord. Some companies are not getting enough help and are closing down.

Pret a Manger, the coffee and sandwich chain with nearly 400 stores in the UK, reached out to their landlords to make concessions after lockdowns depressed their income. In the meantime, 65 percent of the locations are at least temporarily equipped with sales leases, compared to around a quarter before the pandemic. Turn-over lease agreements, sometimes referred to as percentage rents in the U.S., may, however, involve a company paying a base rent that is below market prices and a percentage of gross income that exceeds that.

“We have so far put about 75 to 80 percent of our UK landlords in good supportive positions,” said Pano Christou, Managing Director of Pret.

Last spring, several landlords quickly offered their tenants temporary discounts. In the summer, Hammerson, a large real estate development company that owns shopping malls in the UK, announced a new leasing system with more flexible agreements, lower rental rates and a new rental review system.

“The UK’s historic leasing model has worked,” said David Atkins, Hammerson’s then chief executive officer. “It’s out of date, inflexible and needs to change.”

In Britain, the government has traditionally been reluctant to enter into these commercial agreements, relying on a 1954 law regulating the relationship between commercial tenants and landlords.

“When commercial users take over a property, it is a business-to-business contract,” said Catherine Hughes, associate professor and director of real estate and planning at Henley Business School. “And that affected the way they were seen and regulated – or were not regulated.”

But that could change soon. As government ministers dig deeper into the economy, the department dealing with municipalities and local governments said in December that it would review “outdated” laws in the face of a “deep adjustment” of industrial property.

It is unclear how extensive the coming changes could be. But Mr Abramson has suggestions: He said that long leases that require mandate rents to increase at regular review periods – so-called up-only rental reviews – should be abolished. Clauses should be put in place to allow tenants to leave the home if rent becomes too prohibitive in their area.

But companies shouldn’t be able to use them either a voluntary agreement by the company to change the rental conditions.

There were fewer bankruptcies in 2020 than last year thanks to billions of pounds of government support, but corporate voluntary agreements for large retail, hospitality or leisure businesses have increased: 29 companies launched such a process in the second half of 2020, compared to only four in the same period of 2019, compiled according to data from PwC.

For large corporations paying rent on numerous properties, these bankruptcy agreements are an increasingly common way to close locations and reduce rent. As opposed to going into administration (the UK is almost equivalent to Chapter 11 bankruptcy), a voluntary arrangement by the company allows a company’s directors to remain accountable as they restructure the company’s debt. It can be a useful tool for a company that has a way back to profitability.

PwC found that from June to November 17 large retail and hotel companies with nearly 3,000 locations had voluntary agreements. In two-thirds of the properties rented, the companies reduced their rents or switched to a turnover-based rental model as a result of the agreement.

Recently, big names like the coffee chain Caffè Nero and the healthy fast food chain Leon have made voluntary agreements to reduce their rental debts.

Critics point out that some of the larger companies, including Debenhams and Arcadia Group, have recently failed and initially entered into voluntary agreements, suggesting that the process has not resulted in a proper business restructuring.

The British Property Federation, which represents landlords and developers, said the system was being “abused”, particularly by companies backed by deep-pocketed private equity firms. Despite the frustrations over bankruptcy agreements, Melanie Leech, the group’s managing director, continues to recommend landlords that the best way out of this crisis is to work more closely with their tenants.

“The landlords’ options are diminishing,” she said. “The longer this takes, the more economic damage is caused.”