Landlords and tenants need to work together during COVID
Crowe’s 2020 restaurant and hospitality industry sentiment survey, carried out in September, established that 60% of landlords had not yet agreed to adjust the level of rent paid by their tenants. The widespread temporary closures caused under current Level 5 restrictions, along with the expectation that there will be further trading disruptions into 2021, means that in order to keep rental arrears to a minimum, landlords need a greater appreciation of what tenants can afford and to engage more actively to calculate appropriate rents under current trading conditions.
The rental reduction required will need to reflect the reduced trading revenue and the cost structure of tenants’ businesses. Our survey of restaurant and food outlets highlighted that for businesses who had agreed a 40% or higher rent reduction, revenues were down, and expected to stay, at least 35% below 2019 levels. We believe the scale of rent reduction now required for the retail and hospitality sector is in the category of 40% to 60% of contracted rent.
While these COVID-impacted businesses needing a rental reduction are likely to be in receipt of other government supports such as the EWSS, rates waiver and COVID Restrictions Support Scheme (CRSS), the correlation of a fall in revenue to a collapse in profit is stark. Landlords will need to offer a rent reduction for most of these businesses if they are to remain viable and thus in a position to pay higher levels of rent as revenues recover.
Crowe sees the government’s arbitrary threshold of a 30% fall in 2020 revenues compared to 2019 levels for EWSS eligibility as flawed, in that the measure is too blunt and could cause some businesses not to qualify for support in Q1 2021 if they are just above the threshold.
Landlords should adopt a tapered approach
Crowe recommends putting in place a solution on a case-by-case basis for rents, one that would see a taper down and taper up of rents depending on revenue levels achieved as against the same month in 2019. For instance, on the first 10% of revenue fall, there would be no rent reduction, but for every 1% fall in revenue thereafter, there would be an equivalent rent reduction for that month. To encourage tenants to pay this reduced rent, the discount should only be available on rent paid within 30 days. This would ensure that tenants do not build up arrears and landlords move to the front of the queue for payment rather than the back, as is often the case.Take the example of a shop paying €5,000 per month rent. In this approach, if its October 2020 revenue was down 40% it would only have to pay €3,500, having been given a 30% discount. Likewise, if a restaurant paying €5,000 was largely closed, where it was only doing 20% of its turnover as takeaway, then it would only have to pay €1,500 for that month – a 70% reduction. This tapered approach allows rents to track revenues on a month-by-month basis, so that when revenues pick up, rental income will grow.
What is vital here is that occupiers provide real-time detail on their revenues so that landlords can see how the business is suffering or recovering and set the rent expectations and levels charged accordingly.
Worse-case scenario for landlords
The worse-case scenario for landlords is that to avoid building up rental arrears, occupiers decide to shut up shop in their existing location and look to establish a new operation in a new location when the business environment has improved. The accepted open and shut nature of trading probably allows occupiers to transfer and retain a similar level of trade following a move to a new location, and the once-off cost of the move may be more than offset by the rental saving. It probably gives their business a better base for survival than just kicking an unaffordable can down the road in terms of continuing with unaffordable and unpaid rents.This would not be good for landlords. The retention of a tenant who has the capacity to rebuild their revenues and pay increasing levels of rent into the future may be the best of a bad situation for a landlord, and is certainly better than allowing the tenant to fold and leave. Landlords often cite concerns about the need to keep levels consistent for similar units in a portfolio. The tapered solution allows landlords to avoid changing the existing rental levels while recognising that occupiers are facing a lengthy period to rebuild to 2019 levels. It recognises that the impact on revenues is uneven between different businesses and allows for a temporary taper approach to be applied to individual tenants.
US & UK cases
The expectation in the US is that over 25,000 stores may close in 2020, among them many long-established household names, such as:
- Macy’s, who are pulling out of struggling malls which customers are abandoning
- Modell’s Sporting Goods, who cited big box stores and Amazon as competitors taking market share
- Destination Maternity, as expectant mums choose to shop more in the comfort in their own home
- GameStop, who are de-intensifying their portfolio to avoid the inefficiency of the units competing with each other
- Men’s Wearhouse, as men working from home no longer need suits
- Office Depot is closing stores selling to consumers while the company targets the greater potential offered in the B2B services market
- CVS Pharmacy, who are shutting underperforming stores so they can enhance long-term performance of the group
- Century 21 discount store, who have blamed insurance companies for not providing support through loss of profit insurance cover at a time when they needed this
- Hallmark, as fewer people are sending physical greeting cards
The trends in the US are likely to be reflected across the European and Irish high street and shopping centres, which makes the competition to retain occupiers a new priority of landlords.
In the UK, the recent spate of company voluntary arrangements, which has forced the closure or rationalisation of many multi-site UK retailers such as Oasis, Warehouse, Laura Ashley, Cath Kidson, Monsoon and Debenhams, has impacted their Irish stores. The headwinds for the high street and shopping malls are likely to remain and cause many more closures over the next few months.
Irish cases
In Ireland, we can see from recent cases before the courts that the issue of rents is massive for both occupiers and tenants. The judgement in the case involving retailer New Look shows that the courts expect meaningful negotiations to have been undertaken before protection under examinership is sought, and using a scheme of arrangement to reset the rents to lower market-based levels should only be a last resort. The Pamela Scott store closures also cited high and unaffordable rents as the reason why certain stores had to close while others could remain open. We have lost Monsoon, Mothercare and Debenhams recently and all of these brands had previously had issues with rent affordability in light of shrinking spend on the high street and in shopping centres as online retail gobbles up more market share. It looks as if their previous rental reduction arrangements were not robust enough to ensure they stayed in business.Landlords need to act now
Perhaps the lesson to be learned is that an earlier intervention by landlords and a compromise on reducing rent or trading footprint could have allowed these businesses to remain open with a remodelled operation rather than leaving empty stores in these locations.
Clearly there will be a requirement for landlords to pre-empt changes to the retail environment and to work with occupiers to stave off these worse-case outcomes. This is an opportunity for landlords to drive innovation which might see new entrants to shopping districts, perhaps re-invented department stores, units that offer collections for larger brands or other combined service offerings that will drive footfall.
For more information read our recent article on rent abatement negotiations.
For assistance in considering the appropriate landlord and tenant strategy and establishing a basis for tapered rent, please contact Aiden Murphy or a member of our corporate finance team. Crowe also provides a full range of restructuring and insolvency services including examinership and liquidations, which are useful tools to bring pressure and focus on having landlords engage and help reduce rents.
