Aurora Fashions- fashioning Leases for tough times

I was not surprised to learn that Aurora Fashions has entered into negotiations with Landlords seeking favourable rent and other terms. This is hardly surprising against a backdrop of stubborn inflation and persistently weak economic growth. When you throw in business rates (which it has been estimated costs the high street some £175m) and empty property rates it is no wonder the future looks bleak. Thus, many businesses will not want to be locked into a 'straightjacket Lease.' Many Tenants will try to negotiate monthly payments, rent free periods or even less onerous break options. As the economy continues to flatline, we may increasingly see new Leases replacing the old 25 and 50 year Leases. What will the new Leases look like?

• They may well be as short as 5 years or even less. What qualifies as a 'strong covenant' today may not tomorrow.
• They could exclude the operation of the Landlord and Tenant Act (LTA) 1954. This will alleviate the Landlord's concern that an underperforming Tenant will not 'move on' once their term has expired.
• Break clause conditions may well be less onerous. Traditionally, Landlords have drafted very tight and narrow break clauses designed to penalise a leaving Tenant. Lax break options will allow a Tenant to move on and the Landlord to create a diverse mix of Tenants in their centre or premises.
• Restrictions on assignment may well be relaxed. A struggling Tenant may wish to sub-let part of their premises to an under-Tenant. A Landlord should be encouraged to view this positively if it will allow a Tenant some breathing space to trade.

In short, a new style Lease suited to tough economic times contains advantages for both the Landlord and Tenant. It gives a struggling Tenant some leeway and allows the Landlord the chance to easily bring in new Tenants if things don't work out. The recent trend of administrations may well be showing that new fashions are replacing old ideas...

Conservation covenants

I have been following the recent BBC programme- 'The Planners.' Briefly, it follows developers up and down the country whose ambitions for development are pitted (and usually thwarted) against the wrath of local objectors and the scrutiny of local planning committees. This revealing series illustrated just why planning law is such a stimulating and interesting (albeit niche) area of law. It concerns politics, power and personalities. It is far from being dry and mundane.

Despite the above, developers of commercial property and residential housing schemes should be aware of the latest consultation paper published by the Law Commission:

http://lawcommission.justice.gov.uk/areas/conservation-covenants.htm

The paper considers the case for conservation covenants. Such covenants would be entered into between developers and landowners and a responsible body (charities / local or central government) with the explicit aim of heritage and agricultural land conservation. Such covenants exist in other countries but not the UK. Such covenants would be long lasting and designed to protect the land even after the landowner has parted with possession. Unlike restrictive covenants, they would affect both Freehold and Leasehold land and can be positive as well as negative. The Commission asserts that only 'responsible bodies' such as charities would be able to create conservation covenants. The idea is to preserve the environment for future generations. We shall have to watch this space to see how such an idea will work in practice. Developers are well advised to keep an eye on the consultation.

I have no objection to the preservation of the environment. The concerns of local residents must always be borne in mind when considering new development. However, economic growth depends on new employment opportunities through the creation of new homes, retail and leisure units. Conservation covenants may well have a laudable aim. However, the Law Commission may end up creating (rather than solving) more problems if its proposals end up thwarting much needed urban development and renewal.

Property implications of the budget

On my return to writing this blog (my hands have been rather tied as of late) I felt it pertinent to discuss some of the most important aspects of last week's budget. Overall, no major surprises. Osborne delivered a political budget. It wasn't exactly 'rabbits out of hats' but it was undoubtedly populist in tone and, frankly, did little to address the structural flaws in the UK economy. So not quite an omnishambles budget?

The main provisions of interest to the property industry are thus:

• £3bn of extra capital spending was announced for Infrastructure investment- on the one hand this is welcome news for the property industry. Investment in new schools, bridges, roads and railways can only have a positive effect on economic growth. However, the money does not start to come on flow until 2015/16. It would be more beneficial, to have the full effects of the investment coming on stream now.

• New mortgage guarantees and shared equity schemes for first time buyers- the government promised new mortgage guarantee support for first time buyers of new build residential property. We shall have to watch this space to see whether or not it will lead to increased activity in the property market. Funding for Lending had a small effect on the property market. That said, there is disappointment that the Chancellor did not do more to extend the scheme to assist SME's and business tenants. Lenders are more reluctant to lend to a business tenant than they are to a residential mortgagee. We've had project Merlin, quantitative easing, credit easing etc. All seem to have had a negligible effect on increasing lending to SME's.

• A corporation tax cut to 20% and a new employment allowance (through cuts to employer's NI contributions). The benefits are obvious. Cuts to corporation tax and NI will only reduce the business tenant's overheads. This is surely welcome relief at a time when many tenants (particularly in the retail sector) are struggling with rising rent bills. That said, the Chancellor did miss the boat and failed to listen to retailer's concerns regarding business rates. Most retailers will face a rates bill of £175m this year. I have stated before on this blog, that many Leases are up for renewal in the coming years. If no action is taken to alleviate the stress placed on retailers, then tenants may be forced to leave their properties when their Leases come up for renewal. This will result in the nightmare scenario of an empty property for the Landlord.

• An 'annual tax on enveloped dwellings' (ATED) will come into force this April. This applies to companies who purchase high end residential property. This is in addition to a stamp duty rate of 15% (for properties worth £2m or over purchased by a company) and a capital gains tax charge of 28% on a gain made by 'non natural persons.' The government does not want to deter property investment made for genuine commercial reasons. Thus, there are reliefs from the ATED e.g. if the property is purchased for charitable purposes, or is made open to the public for at least 28 days a year. This is indeed laudable, however it does show how heavily property is taxed in this country. This could well become a general trend as the government moves from a tax system based on income (which is highly mobile) to one based on property and other assets (which cannot be moved so easily). This is especially so as politicians continue to explore the possibilities of a much vaunted 'mansion tax' on high value residential property. The above suggests that it may not be necessary.

I have analysed the main provisions of the budget that will be of interest to the property industry. In short, the Chancellor has missed an opportunity by not bringing forward capital investment sooner, by not cutting business rates and by not extending government schemes to increase lending to business tenants. Many Leases are coming up for renewal. The Chancellor missed the chance to deliver a budget that would save Britain's high streets. Perhaps it has turned out to be something of an omnishambles after all...

The rise of turnover rents

It is amazing to think how many high street businesses have been consigned to the graveyard. It is difficult to know what can be done about it. There are the usual mooted suggestions- business rates cuts, greater use of 'click and collect' options by stores etc. However, I was interested to read this article in Retail Week:

http://www.retail-week.com/sports-direct-offers-turnover-deal-on-republic-stores-rent/5047295.article?blocktitle=More-News-and-Insight&contentID=5271

Republic, the fashion chain, was bought out of administration by Sports Direct (SD). SD offered Republic's Landlords 15% of the stores turnover to cover rents, rates and service charges. SD claims that 'given the number of voids on the high street, retailers’ relationships with landlords are coming to the fore. We’re doing something that’s really innovative that should be mutually beneficial.' Voids means empty shops and units. SD have also signalled that the new contracts would retain some flexibility, so that Landlords can walk away if they become unhappy with the arrangements.

The last part is interesting- the proposal by SD should be mutually beneficial to both Tenants and Landlords. This could indeed mark a sea change in the retail industry. Previously, I had written about how H & M had delivered a tough new set of Lease proposals to its Landlords. SD's proposals are completely different and a breath of fresh air. Landlords get their rent and have an interest in the continuing success of the businesses. Times are tough for Landlords- we are all aware of the rent problems they face after an administration, CVA or pre-pack deal. Landlords are caught between a rock and hard place in Lease negotiations- trying to protect the value of their investments (and the interests of their fellow investors by getting a good rent deal) and satisfying the Tenant who could walk away. SD's plans could mark a complete shift in the relationships between commercial Landlords and Tenants. Plans where both parties have a stake in the continuing success of the business and its property portfolio. We shall have to watch this space as to whether or not such proposals become commonplace in the retail industry.

Business rates rethink

I have written many times on this blog about the harm to SME's caused by business rates. The next re- evaluation is not set until 2017. In some places, rates can be higher than rents. The 'Fair Rates for Retail' campaign has called upon the Chancellor to freeze or (preferably) cut business rates in the upcoming budget. Business rates are, in the words of Kwasi Kwarteng MP (in an article in today's Guardian), a 'tax on the high street.' The Chancellor would do well to listen to his colleague as well as to struggling businesses on our high street. February showed that retail sales had grown by 2.7%. This is positive news. However, consumer spending is likely to remain depressed. The recent string of high street administrations shows this. Therefore, I was pleased to read this:

http://www.retail-week.com/in-business/policy/treasury-considers-business-rates-rethink-as-pressure-from-retailers-grows/5046900.article?blocktitle=Most-popular&contentID=-1

The government has signalled that it is considering a u - turn on business rates. Unlike the others, this u-turn will be deeply welcome and much needed. Ian Cheshire, CEO of Kingfisher and Chairman of the BRC (British Retail Consortium), states that that were it not for long-term leases he would close a quarter of the DIY retailer’s stores due to the tax burden. The following Retail Week article:

 http://www.retail-week.com/in-business/fair-rates-for-retail/fair-rates-for-retail-retailers-urge-rates-freeze/5041237.article

also makes clear that two years of punitive rate increases have added more than £500m to costs. The BRC Director General was right to assert that 'the most important four letter word in Westminster should be jobs.' The government already boasts that it has already created more than a million private sector jobs since taking office. Whether it has or hasn't, the fact remains that a business rates cut would increase the pace of job creation. Job creation is the strongest argument for a rates cut.

The Chancellor should listen. According to the article- the government is considering the way that increases in rates are calculated (by linking them to the lower rate of CPI rather than RPI). Business rates are bad news all around- bad for Tenants struggling to make a profit, bad for Landlords who need rent paying Tenants in their properties and bad for a government in need of tax receipts to balance the books. Will the Chancellor freeze or cut rates? Only budget day will tell. If the Chancellor wants a big headline initiative (that will actually have any effect) then he knows what he must do.

Retailers playing hard ball

I was extremely interested to read this article in Retail Week:

http://www.retail-week.com/property/analysis-the-retailers-pursuit-for-favourable-uk-lease-terms/5046366.article

Fashion retailer, H & M, has put forward a tough new set of terms to its Landlord. The terms include:

• A reduction in the amount of rent it would pay if 15% of a shopping centre it occupies falls vacant. If this were to happen H&M would immediately cease paying the base rent and would revert to simply paying the landlord a turnover-linked “top-up” fee.
• The fashion retailer is also stipulating that if the vacancy rate of a centre remained at 15% or rose over a set period, it could further reduce its rent, regardless of whether its turnover stays the same or increases.
• Ultimately, H&M could then terminate the lease if it still wasn’t happy.
• H & M will also have the option to abandon a Lease immediately if a big anchor store in the centre (e.g. Debenhams) leaves.

In my opinion, the above confirms what I have argued in previous posts. Landlords fear empty stores above anything else. Inflation is running at 2.7% (CPI) and 3.3% (RPI) respectively. The article does make clear that turnover Leases are increasingly common in shopping centres and are another weapon at the Landlord's disposal to create a diverse mix of retail Tenants. The article also alludes to problems with the Landlord and Tenant Act (LTA). It gives the example of Westfield and asserts that many stores (in Westfield) have Leases of varying lengths both in and outside the remit of the LTA. It remains to be seen whether or not more retail Tenants will take a leaf out of H & M's book. However the option of turnover Leases, as well as Leases outside the remit of the LTA (and thus the security of tenure provisions giving the Tenant the option of moving on when the Lease expires), would suggest that the Landlord is not completely powerless. The article makes another interesting point- what is a strong covenant (i.e. Tenant) today may not be tomorrow. The recent high street administrations have proved this. If retail Tenants start playing hard ball, Landlords should remember that they are not totally powerless.

Let there be light...or not...

The Law Commission has opened a consultation on its provisional proposals to reform the right to light (which is commonly claimed by property owners concerned to protect their house from developers). The consultation proposals can be found here:

http://lawcommission.justice.gov.uk/news/rights-to-light-news.htm

In most cases property owners will acquire the right to light through prescription i.e. if they have enjoyed the right for an uninterrupted period of at least 20 years. The right to light is difficult to deduce from title deeds or Land Registry documents. Other common law juridictions (e.g. New Zealand) have abolished the right to light through prescription. The right is controversial because it presents a conflict between the right to light and the developer's right to build on their land. The conflict was illustrated in the case of HKRUK II Ltd v Marcus Alexander Heaney (Heaney) 2010. In this case, Heaney's right to light was blocked by the developer. The court awarded a mandatory injunction so that the developer was forced to take down the extra floors of the development that interferred with Heaney's right to light. The court was influenced by the fact that the developer knew that they were committing an actionable breach of Heaney's right to light. Since then, developers have naturally been cautious of interferring with rights to light. The consultation has proposed the following:

• It should no longer be possible to acquire rights to light by long use (known as “prescription”).
• The introduction of a new statutory test to clarify the current law on when courts may order a person to pay damages instead of ordering that person to demolish or stop constructing a building that interferes with a right to light.
• The introduction of a new statutory notice procedure, which requires those with the benefit of rights to light to make clear whether they intend to apply to the court for an injunction (ordering a neighbouring landowner not to build in a way that infringes their right to light), with the aim of introducing greater certainty into rights to light disputes.
• The Lands Chamber of the Upper Tribunal should be able to extinguish rights to light that are obsolete or have no practical benefit, with payment of compensation in appropriate cases, as it can do under the present law in respect of restrictive covenants.

This should result in greater certainty for developers- particularly the abolition of prescription and the introduction of a statutory notice procedure prior to exercising the right. Developers will have to wait longer though to see the ink dry and the proposals set out in law. Only then will developers be able to get on with development without having to look over their shoulder constantly. Right now, the above is a shining light that will bring the unfortunate developer in from the dark.

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