It is clear that a number of real estate occupiers are withholding rent despite having the cash to pay. This isn’t just a moral issue; it is a systemic threat.
Goodwill is creating the flexibility needed to manage today’s cash crisis. Many tenants, landlords and lenders are working together to manage their cashflows. Everyone is looking for some breathing space. But undermining that goodwill will create distrust.
'If they don’t pay, why should I?'We saw how fast distrust spread among banks in the global financial crisis. It caused liquidity to evaporate in that sector with consequences for the wider economy that were unthinkable at the time. We shouldn’t forget how entrenched the real estate industry is in the economy or the financial sector. Even our pensions directly or indirectly rely on rent cashflows.
And so, we shouldn’t underestimate how quickly distrust created by ‘can pay, won’t pay’ occupiers could worsen today’s cash crisis and start a chain of events that are inevitable in their impact.
Code of Honour
In response to this threat, the Government has formed a working group with organisations in the commercial rental sector such as the British Property Federation and Revo.
Following discussions with the group, the Government has announced its plans to publish a Code of Practice for retail, leisure and hospitality businesses and landlords before the June payment day (24 June).
The draft code as highlighted in the industry press over the past week indicated ‘…not the intention of this code to undermine of alter the basis of the legal relationship of existing lease contracts…’ Further to this the statements that ‘tenants who are in a position to pay in full should do so…(others) should pay what they can…landlords should support affected businesses where they can afford it.’
All eminently sensible but it has to be said, ambiguous. ‘Tenants in a position to pay in full’ and ‘landlords who can afford it:’ who is to determine this? Are tenants and landlords going to be judged against guidance to ‘provide relevant financial information’ if concessions are sought by tenants or denied by landlords? The suggestion of a third-party mediator does sound sensible as long as the right companies are used to facilitate this.
The largest omission, which there is still time to add to the final paper, is for the Government to underwrite rents.
The Code looks to encourage 'fair and transparent discussions between landlords and tenants over rental payments during the coronavirus pandemic and guidance on rent arrear payments and treatment of sub-letter and suppliers.' This has the intention to promote collaboration within the sector and ensure no one part of the chain shoulders the full burden of payment. It is also likely to stress the importance of service charge and insurance payments in full.
The Code will be a temporary and voluntary framework. This ensures contractual arrangements take precedent and allows stakeholders the flexibility to work out their problems case-by-case. But the Code’s voluntary status also risks it not fixing the problem it needs to solve – if ‘can’t pay, won’t pay’ tenants are ignoring their contractual obligations, why would they follow voluntary guidance?
As a hint of what may come, the Government has already said it will make the Code mandatory if necessary.
Last quarter’s rent collection rates were bad enough to spark talk of systemic risk and Government intervention: but how bad were they?
Property managers collect 80% of rent on the due date in a normal quarter. But collection rates in the March quarter were at historic lows, down 30 percentage points on average for all property types. Retail properties’ rates had halved.
Lockdown started only 2 days before rent was due – close enough for businesses to have a full quarter of trading behind them but so close that the full effects of trading under lockdown were still unknown and many rental transfers had already completed.
The knee-jerk reaction for many businesses was to delay rent payment. As lockdown progressed, the fortunes of businesses in different sectors diverged. Weak trading confirmed many tenants’ fears and retail and leisure sectors felt the most pain, leaving their rent collection rates depressed. Those with retail portfolios – such as Intu and Hammerson, had much lower collection rates compared to the 80% on offices.
Source: Remit Consulting
Meanwhile, office-using businesses have kept productivity high thanks to remote working and logistics firms are overcoming their supply chain issues. Rent collection rates improved by around 30 percentage points between the due date and 49 days after the due date for office and industrial properties. For comparison, retail only improved 18 percentage points over the same period.
Although the Government is consulting with the retail, leisure and hospitality sectors, the Code needs to apply to all property types. Low rent collection rates are an industry-wide challenge.
Low rent collection rates will not be a one-off event. We expect further challenges at June quarter and collection rates are very likely to be worse than those seen in March.
Our belief that collection rates will be lower this quarter is based on more than a hunch. A good guide for June comes from our experience of the 28 May Scottish Quarter day. We collected 45% of rents on the due date for the Scottish Quarter day from a mixed portfolio, but we also saw some leisure and food-and-beverage-led schemes with rent collection rates at low single digits.
Despite ongoing issues, the industry should be incredibly proud of how it has coped since lockdown. Tenants have been under extreme pressure, but many have still been open and proactive with their landlords. In turn, landlords have granted monthly rents, deferrals, payment concessions and in some instances rent holidays for tenants. Likewise, lenders have shown that they can be flexible by restructuring facilities and giving borrowers payment holidays.
Most stakeholders understand that avoiding reputational risk in an industry built on long-term relationships is essential. Others should keep in mind that reputations are not owned, they are rented. All stakeholders want to be part of the recovery, not in a state of financial distress when the recovery arrives. It is in no one’s interests to see swathes of empty premises on the other side of this pandemic.
Across all industries, people’s ability to feel comfortable, safe and secure will be paramount to business recovery. Organisations will need to help people return to open commerce with a sense of trust. At the same time, businesses and investors alike need trusted guidance to manage real estate in the current climate, and to predict what's next for the industry. Cushman & Wakefield is ready to help ensure they can do so with confidence.