By - Kunal Sawhney
Summary
- Shorter leases would translate to lesser certainty over rental incomes and future occupancy
- Businesses have struggled to clear their rent dues during the unprecedented crisis
- Investors need to be watchful of investing in the real estate sector as the UK officially enters into recession
The UK is although is said to have passed its peak in terms of the carnage caused by the coronavirus pandemic, and most of the economic activities are up and running, there are certain sectors in the economy which are still feeling the tremors caused by the outbreak of the deadly virus.
The High street retail and businesses have been severely impacted as they suffered lockdown, which was aimed at curbing the spread of the virus. Even though the lockdown is now lifted, consumers still fear to go out and buy things from stores. In addition, the consumers are into savings mode due to prevalent uncertainties in the economy with reference to Brexit and the coronavirus pandemic.
The economic fallout and the carnage in the commercial sector have now spilt over to the battered real estate sector. The commercial property owners were making concessions to the struggling tenants and business owners during the unprecedented crisis. According to industry experts, the commercial leases are now getting shorter by almost a year. Shorter leases would translate to lesser certainty over rental incomes and future occupancy.
As businesses exercise caution and avoid making long-term decisions due to prevalent uncertainties such as Brexit and Covid-19, the trend towards a shorter lease is expected to rise. According to industry experts, businesses are negotiating with property owners over term reductions. Moreover, businesses nearing maturity are choosing to renew or extend their existing lease agreements with added flexibility.
Property rent is an ideal source for many of us. However, it is a fixed cost from a tenant point of view. Irrespective of the market conditions, the tenant is liable to pay rent, which is decided and documented mutually in the lease agreement. The tenant is liable to pay the rent amount for the entire term of the lease. Due to the unprecedented crisis of the novel coronavirus, businesses are really struggling to remain afloat and have latched on to support schemes backed by the government.
Also read: The Plight of High Street Retailers Amid the Covid-19 Crisis
The plight of the commercial properties and the retail connection
The commercial property industry of the United Kingdom has just received a huge shock in the form of a sharp fall in rent receipts for the quarter ending June 2020. Though it was known that the impact of the coronavirus pandemic would hit them at some point in time, nothing can prepare you for a shock of this magnitude. The industry which was due to receive a rental revenue of nearly £2.5 billion during the second quarter of this year has just received only half of the rent due, according to the British Property Federation.
The retail sector has been so badly hit by the lockdown, that it saw a very drastic fall in the mall footfalls, which impacted its revenues acutely and in fact, some of these companies were pushed to the brink of bankruptcy. It is though worth noting that several retailers have reopened their shops and the situation has started to improve gradually since May. It is expected that their financial condition may improve slowly in the coming few months.
In the UK, an average lease lasts for six years, according to market experts. This term has gone down by 10 months on an average. Businesses are looking forward to shortening the lease term, flexible options, and more agile office solutions amid the economic pressures and uncertainly brought on by the coronavirus pandemic and Brexit.
Many of the UK retailers are likely to initiate discussions with the UK’s biggest proprietors. As a result of negotiations between the two, the restructuring of leases for the property is more likely to happen. Further, this could result in the exercising of CVA (company voluntary arrangement) in case of disagreements between both parties, which would empower the business to stay afloat by rent reduction.
However, there are a few instances in the past where tenants have misused CVA to reduce their rents substantially. CVA is a tool to protect vulnerable businesses and not to be used as a weapon against property owners.
Case of Intu Properties Plc (LON: INTU) - trading cancelled at LSE on 2nd July
Intu Properties Plc is a British REIT (Real Estate Investment Trust) firm that owns and manages high profile commercial real estate properties in the United Kingdom and Spain.
Even before the pandemic hit the shores, Intu Properties had been in deep financial trouble. Till January 2020 the company had been facing a challenging market environment due to the negative headwinds emanating out of the pre-Brexit jittery. Many of its customers were delaying their decisions and waiting for the business environment to improve before renting out shops. In the year 2019, the company had suffered a loss of £2 billion, and currently, it has a debt burden of £5 billion on its books, which is up for maturity by early 2021 and needs urgent refinancing.
Since the lockdown was imposed, the company did receive some government support in the form of various stimulus spending made by the latter to support businesses in the country. Intu was able to place nearly 60 per cent of its shopping centre staff and 20 per cent of its head office staff under the benefit of that scheme. However, it has not been able to avail of the government loan facility to fulfil its debt obligations, which is the reason why it is seeking fresh lender support. Currently, the company is in discussions with its lenders to allow a moratorium period of 15 to 18 months from the repayment of capital and interest. Whether the company will fall into administration or not is highly contingent on these discussions.
Weak economic recovery making the situation worse
GDP (Gross Domestic Product) has fallen by nearly 21 per cent in the quarter ended June 2020, according to data from the Office of National Statistics (ONS). The UK has officially entered a recession. Due to the carnage caused by the novel coronavirus, there are a lot of uncertainties prevalent in the market. The government support schemes are likely to be called off in October 2020. The real impact in the real estate market would become more apparent in the upcoming months. To exacerbate further the weakened labour market could drive the housing prices southwards in the near term.
Moreover, the British government is being advised to convert struggling high street retail into housing projects. According to the Social Market Foundation (SMF), vacant commercial buildings should be converted into new homes.
Also read: Rising UK House Prices Despite Deteriorating Economy; Focus on Taylor Wimpey & Crest Nicholson
For real estate investors, sale, or lease of the property to retailers was one of the key objectives to capitalise on their portfolio before the Brexit uncertainties and coronavirus pandemic took a toll on the commercial property segment. With the transition of customers towards online sales and retailers’ encountering high operating costs resulted in the lesser lease tenures, lower rental income for the real estate investors. The political & economic uncertainties prevalent due to Brexit and novel coronavirus respectively, have resulted in the occupational and cashflow uncertainty in the future and the market is likely to show more sluggishness in the medium term.