We’re in the same storm, just in different boats

How have cost containment considerations in the light of COVID-19 affected the landlord-occupier relationship?

Myriad references to cost containment in the real estate world have been focussed on mitigating the pandemic’s impact on occupier organisations. Whether nationally recognised brand or small independent, occupier challenges around cash flow, cost mitigation, only necessary expenditure, redundancies, cost of making workplaces safe and accessible or staff retention have been prevalent. While these conversations have their rightful place, we cannot forget that the disruption of 2020 impacted landlords and investors too.

Last year, many investor landlords faced disruption at a scale never seen before; managing the practical closure of their assets, mitigating notable security and safety concerns, as well as facing challenges around fulfilling practical and contractual obligations to insurance companies (inspections and plant checks for example). Landlords of all shapes and sizes have had little or no respite from lenders where they have borrowings (i.e. a mortgage) against their properties. Many smaller landlords can often be very highly geared and were therefore highly exposed to defaulting on their own contractual obligations. For those with developments underway, realistic timeframes were torn to shreds and the cost implications of delays will likely destroy anticipated returns.

Cash management has been king for all

Landlords have had to perform a balancing act of needing to use incoming cash to pay interest on their loans and funding service charge voids with other ongoing and unavoidable costs. Many investors with hospitality led propositions faced particular challenges, from complete closure to enabling servicing and alternative operating mechanisms where feasible.

Increasing vacancy rates create cash flow issues at multiple levels beyond a lack of direct rental income, including considerations around business rates, for which mandatory relief is lost after the initial three to six months. This represents a significant overhead which is not straight forward to alleviate, although opportunities to mitigate this exposure are available. The Makro case in 2012, led by Avison Young Principal Gareth Buckley, set the legal precedent establishing the extent of occupation required to reactivate additional reliefs.

However, there are concerns that HM Treasury, in its fundamental review of business rates, could restrict landlords’ opportunities to use these schemes, significantly increasing the cost of vacant space at the most difficult of times. Avison Young continues to lobby government to maintain the current six-week occupancy period to ensure that landlords can remain in control of their business rates exposure. Proactive management as soon as space is vacant is imperative as retrospective action is far more complex with a high failure rate. Landlords also need to lodge Covid-19 Checks against all their assessed estates, whether occupied or vacant. Allowances will be agreed offering savings to landlords if space is handed back.

A delicate balancing act

Over the past year, landlords have regularly processed and considered impacts of changes to legislation and best practice in relation to their assets. They’ve balanced their contractual obligations to occupiers in multi-let buildings, ensuring full legislative compliance as a minimum and providing services to tenants who remained open and trading, with minimising costs for the benefit of all. Where a building was only half let pre-pandemic, landlords have had ongoing financial liabilities in respect of empty space and paid service charge and insurance for these areas too, more often than not with a reduced income from the rental payments they would normally expect to receive from their occupiers.

Many have experienced claims and conversations around inability to pay rent due to business closures from independents and multinational brands. Some landlords have supported occupiers with practical business advice, marketing support, rent concessions or drawdowns on security deposits. They have had ongoing negotiations with companies needing to exercise break clauses who previously had no plans to do so and suffered their occupiers falling into administration with outstanding debts.

Landlords – guided by their managing agents – have also supported occupiers in returning to the workplace where safe to do so, been through cycles of recovery and tiered approaches, endured the supply chain challenges and costs of providing additional cleaning regimes or PPE kit for communal areas. Some - particularly landlords in the public sector – have simultaneously had to struggle with gaining access to basic systems and technology from home.

What has changed?

An American professor from the University of Maryland recently cited three ways the pandemic has, and is, affecting our psyche – how we think, how we relate to others and what we value - which can be applied to the shift we’ve seen in landlord responses.

A definite positive to emerge from navigating the challenges of the pandemic is the evolving occupier/landlord relationship. While the dynamics have been changing for years, the collaboration and cooperation we’ve facilitated and witnessed over the last year were unimaginable prior to 2020. The level of direct engagement with occupiers by the landlord or by us as managing agent has intensified significantly, with the volume of conversations for larger multi-let office environments, shopping centres and mixed-use developments increasing by circa 40% in some cases.

Communication has made its way to (nearly) the top of the priority list, with all parties sharing information up, down, sideways and outwards; engaging, negotiating, conveying messages of safety, support and hygiene, agreeing desired outcomes, collaborating to achieve optimum position on financials/rent requests and payments. This has facilitated the creation of better working arrangements and environments to enable and encourage employees to safely return to our towns and cities, our workplaces and our leisure venues.

The value of information and attention to detail we have been able to provide to our clients has been appreciated by occupiers and landlords alike, with both benefiting from being kept up to date with ever-changing compliance, legislative changes, guidelines and risk assessments. The preparation of clear processes and channels in the event of future lockdowns – after the end of the first – provided significant value to landlords.

And now what?

It’s not over for investors any more than it is for occupiers, organisations, employees or the general public. What impact is the pandemic going to have on longer term behaviour? What volume of space will occupiers want? What type of space will they need? These are all the questions we are advising investors on.

For example, following the Supreme Court’s decision this month on the effectiveness of Business Interruption Insurance policies, we anticipate a real focus on policies in place across the commercial built environment by both landlords and their occupier customers as to if and how legitimate claims can be made to recover losses caused by the economic devastation of the last 10 months.

While landlords may be seeking to contain costs in similar ways to occupiers right now, they’re seeking to do so with a long-term vision in mind. We are providing intelligence on the purpose of the space, the benefits and costs of location changes, the levels of interest in investment and particular asset classes and the market dynamics and growth sectors.

However, there are also interesting discussions taking place around:

• how landlords help organisations achieve the optimum productivity of their workforce
• how buildings are going to be adjusted to attract workforces back to the office
• how they will address wellbeing needs of occupiers and their workers post-COVID
• how they ensure robust communication of their building or scheme’s brand and benefits to occupiers that may be in their physical spaces less often

Those are the conversations that move away from cost containment and toward effective expenditure. Considering these factors will benefit both landlords, investors and occupiers as we move into a more flexible future and will ultimately make the experience of leaving home to travel to our workplaces not just a short-term novelty, but a personalised and new “normal”.

For more information on how Avison Young can help you in these challenging times, please visit our dedicated Cost Containment hub.