Retail Headwinds – Which Direction Will These Blow Lenders?
21 June 2021
The past 18 months have been a devastating period for retailers, revenue has fallen drastically and this in turn has affected their ability to pay rent. Moratoriums on rent were put in place by the UK Government in an attempt to preserve the retail industry and between March and December last year commercial tenants built up arrears of £4.2 billion.
As a result, retailers have sought rent concessions and many have moved to restructure by way of Creditors Voluntary Arrangements (or CVA’s). This has in turn led to demands for more flexible forms of lease with a move away from traditional “fixed” rental agreements with periodic fixed rents to “turnover” models.
This is a serious challenge for both Landlords and their Lenders and Lenders will need to adapt to meet the challenge.
COVID-19 is not the cause of all the difficulties in this area but it has made this tide turn very quickly and left many Landlords exposed.
In the past few years the retail headwinds blowing Landlords into a difficult position included high occupational costs, for example, a national living wage, pensions contributions, commodities pricing and exchange rates, and the rise in online retailing.
The combination of the pandemic and the headwinds is likely to result in a more notable shift from traditional “fixed rent models” to “turnover models”.
What will these new leases look like?
A number of Turnover Models are emerging:
- Pure Turnover with no Base Rent-Rent is based purely on the turnover of the business.
- Turnover Rent plus Base (this is likely to be a retrospectively assessed base rent to account for seasonal turnover).
- Total Occupational Cost (TOC) i.e. rent is agreed as a set % of turnover, the Landlord must then deduct all costs under the lease from this figure, e.g. service charge, rates etc., and then Landlord keeps remainder as rent.
There is likely to be a shift to much shorter leases like the European model of 3, 6 and 9 years with capital contributions taken as very extended rent free periods and monthly rents are likely to be seen in future rather than quarterly payment.
With rents arguably a “free float” this will inevitably impact on the predictability and management of debt serviceability for Lenders.
What action will Lenders need to take?
- Lenders will need to reassess their lending strategy and their risk appetite for this type of lending.
- Lenders will need to consider whether a typical fixed loan structure is appropriate for this type of lending.
- Review existing loan book to consider how the valuation of existing security may change if the lease structure changes to a turnover rent model.
- Consider credit policies and procedures including information required for monitoring portfolios, Loan-to-Value thresholds and financial and non-financial covenants.
- Ensure flexibility in forbearance policies to ensure Lenders can deal with variations in loan repayments. If rents are payable based on turnover levels this will also lead to a variation in loan repayments by the Landlord particularly if the turnover rent is cyclical.
Whatever the future holds in the Landlord and Tenant world in the UK, there is no doubt that change is coming.
*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.