The phrase "non-essential" has taken on a new meaning in 2020 with the closure of most retail stores, eat-in dining and places of leisure. Despite this period of lockdown, the market is still active and leasing activity has not abated. As we begin to look forward to what might change, and what form that change might take for landlord and tenants in commercial property, it is clear that the status quo has been disrupted in a manner and pace which was largely unexpected. The last year has shown the importance of flexibility and commercial partnership at all levels; a trend which will continue into 2021 and beyond.
At the core of any landlord and tenant relationship is the lease. Increasingly short term leases have become more attractive due to the greater management of risk and the increased flexibility they offer in term length. While historically it has been retail and leisure businesses which have demanded greater flexibility, the virus outbreak has shone a light on another class of tenant who may want to expand their options: office tenants.
With the shift to home working which the pandemic has forced upon large swathes of the population, a new era of living and working has been brought to the fore. Just as food halls and pop-ups offered an accessible sector of the market to restaurateur and retailers, so now has co-working perhaps offered something to the large class of employers who no longer need to provide designated desks for all their staff five days a week.
This is a very real concern amongst ministers. There have been talks of a "back to work" week to revive the City later in the spring to reinvigorate businesses which, so reliant on office workers for their trade, have been badly affected by the shift to home working. While thoughts of a grand re-opening in the spring are likely to be delayed, the prospect is sobering. One year ago the notion of having to entice workers into the office would have been furthest from anyone's mind, yet today business owners are faced with the threat of permanent change which may alter the face of key districts in large city centres.
Commercial leases need to adapt to these changes by offering the same flexibility that the parties entering into them need, for example through shorter terms, early or frequent break rights, turnover/revenue rents and varying rent review mechanisms, for example reconsidering the artificiality of upwards only rent reviews. We are seeing landlords sharing risk with their tenants by way of service charge caps, qualified repairing and reinstatement obligations as well as other attractive financial incentives.
In December 2020, the government announced the launch of a review into commercial landlord and tenant legislation. The aim behind this review is stated to be to encourage better collaboration between commercial landlord and tenants and an improved leasing process to support the commercial real estate sector. This is a reflection on the precariousness of the current position. Many high streets were facing huge pressures from e-commerce and large overheads at the beginning of 2020. The impact of the pandemic with the lockdowns and restrictions placed on many retail and leisure venues has brought even more uncertainty with many businesses struggling to survive.
The government's willingness to change the status quo can be seen in the recent planning law changes with the new Use Classes Regulations last autumn; the biggest shake up to the uses classes in decades. Its aim is to ease changes between use classes and facilitate the repurposing of vacant units. If we see a similar disruption to the well-established Landlord and Tenant legislation, this could fundamentally change many lease practices as we know them. The outcome of the government's review will be very interesting.
This repurposing of spaces will become increasingly important following the pandemic as our working lives adapt. It is expected that working from home will become more commonplace and this will lead to a downturn in footfall in some areas where offices are prevalent but an uptick in residential areas where local businesses will thrive. Dark kitchens, and the evolvement of dark stores – stores as fulfilment centres for local pick-up rather than browsing – show the changing needs of customers and the need for local planning law to keep pace with consumer demand.
Repurposing will also become even more crucial following the end of the moratorium on forfeiture for commercial tenants for non-payment of rent, which is set to end on 31 March 2021 (although a further extension is not beyond doubt). When this does end there is likely to be a flurry of activity as landlords seek to consolidate their losses. It is very likely that we will see a number of businesses sadly going into insolvency after the moratorium ends. Landlords will need to consider what they will do with units and how to align their sites with a new marketplace.
Given the number of high profile CVAs which have emerged in the last couple of years, landlords will be understandably keen to protect themselves where they can. Leases might include an automatic provision that if the tenant enters into an act of insolvency the rent automatically becomes payable weekly or monthly, rather than quarterly in order to preserve cashflow. In a turnover-based lease, a landlord may want a return to fixed base rents in the event of turnover rent falling below a certain threshold, or to be able to terminate the lease and find a tenant with a higher revenue stream. Landlords may want to go a step further and include an express requirement from the outset of the negotiations in a lease guarantee for a guarantor to top-up the rent where it has been reduced by a CVA. All these issues will need to be considered on a lease-by-lease basis.
The environmental impact of our buildings will also come under increased scrutiny. From 2023, commercial units will be unlettable if they fall below a rating of "E". Bringing older buildings up to the appropriate environmental standard will require investment; in some cases it is likely to trigger a wholesale demolition and redevelopment, particularly where landlords own blocks of buildings or an estate where re-development could provide an opportunity for regeneration. Smart buildings are likely to also become more sought after.
Now is the time to be thinking ahead and considering opportunities in the real estate market. As the vaccine rollout gathers pace and a return to filled streets and busy high streets for good becomes a realistic prospect there is a hope that life will return to "normal". While the pandemic has overwhelmed many individuals and businesses in the sector there is recognition that collaboration will be more important than ever.
The government's proposed review of the Landlord and Tenant legislation reveals this at the highest level, as does the plan for a revival in the Square Mile through the "back to work week" and the freeze on the business rates multiplier in 2021/22 (a move welcomed by many but which it is clear may now need to be revisited in light of the likelihood that restrictions may still be in place after Easter).
Perhaps the most effective collaboration however will be what takes place on the ground. It is not just local or national heads who can bring businesses together; landlords and tenants can do this by uniting in their mutual aim to create a buzz, drive footfall and generate trade. The shift towards a turnover rent model is indicative of a more shared responsibility between the parties. There is an incentive to create interesting areas and this can be seen in the investment in place-making around which new developments centre. Landlords need to be sensitive to what tenants need to make their businesses successful and tenants need to be co-operative to enable all the occupiers to benefit. All we need now is the minor matter of the lifting of lockdown.
Want to hear more from us? 
