With the coronavirus lockdown forcing landlords and occupiers to share the pain of lost revenues, there are increasing calls for changes to the legal relationship between the two.
Participants at the Real Estate Tomorrow conference debated the options open to the market, as this reassessment takes place.
Frank Croston, partner at Hamilton Hotel Partners, said now is the time for a fundamental rethink. “My fear is that a lot of people will be planning their way back to the old normal – and that will hurt hotels as an asset class. I’m not sure that’s going to work – how can we design a new model?”
Theodore Kubak, managing partner at Value One Arbireo Hospitality, said there was a need for a smart, resilient solution with a review of how rent-free periods and guarantees are structured. “Our industry has certain opportunities to spread risk.”
“The problem for the traditional lease model, is it is not built to handle the cyclical market,” said Croston. “The key ingredients are a lower base component and a higher variable element.”
One fan of mutually shared risk is Anders Nissen, CEO of Pandox. “Revenue based leases have been in our industry for 25 years,” he declared: “We don’t want fixed leases, that’s the highest risk you can take.”
He has declared himself a big fan of flexible leases, arguing that the arrangement binds landlord and occupier to working for mutual benefit. “If you have a long fixed lease, you can be passive. For me, signing a fixed lease is something I would never do.” Unless it was in an acquisition – and even then, he would look to switch the agreement down the line.
CBRE’s David Batchelor said the changes are not just in the hotel sector. “There is a fundamental shift in how the consumer accesses real estate, and the real estate investor is seeing that net lease is not a great way to reduce risk.”
“I’m now starting to see landlords not only moving to turnover, but also to taking on franchises.”
But not everyone expects massive change. Cedrik Lachance, director of Reit Research at Green Street Advisors, said: “I don’t think we’ll see a tonne of turnover rent.”
Croston said some of the desire for change is coming from investors. “What is interesting, is the drift of more institutional investment into the sector.” Some, he added, are now seeing that they benefit more from the profit stream, by having direct exposure to the operational business. “That is very encouraging.” Funds can find ways to move away from rigid leases, he insisted.
At Pandox, Nissen declared himself a buyer of existing standing assets, rather than new builds. “Building a new hotel is often not a good idea.”
Nissen said he expects to see low prices from motivated, distressed sellers, but otherwise he has been surprised how little values have moved. “Many people think there will be a flood of distressed properties on the market – I’m not so sure about that. But if it comes, we will definitely be there.”
HA Perspective [by Andrew Sangster]: There were six themes I noted during the Real Estate Tomorrow event. The first was the acceleration of change but the second was the moving of fixed costs to variable. And clearly leases were top of this list for lessees.
From a landlord perspective, switching from an unsustainable fixed lease to a variable lease structure is not always a net negative. In the short-term there is clearly pain but it means the property owner gets to share in the recovery. And in many cases, forcing the issue will lead to forfeiture and all rent being lost for a period.
In the UK, commercial landlords have been hobbled in their responses to the crisis by the Government’s decisions to protect occupiers with evictions banned until the end of September. No action can be taken unless 189 days of rent are owed.
While there have been specific restrictions on landlords taking action on tenants, the treatment of landlords by financiers was left to advisory notices. UK Finance, the trade body, said its members were “committed to supporting viable businesses and are engaging with their landlord customers”.
The “flexible support” on offer from financiers was listed as including amendments to facilities and capital payment holidays. This is a fine short-term support but does rather depend on business returning in a V-shape. And even then, capital structures are going to be under pressure.
A high-profile tenant support group called Hospitality Union comprises more than 3,000 business owners has called for a #nationaltimeout which is a nine-month rent holiday. The founder, Jonathan Downey, has been a passionate and engaging advocate for this approach but it is one that unfortunately is likely to lead to longer term pain across the industry and only short-term relief.
There have to be difficult discussions between tenants and landlords on the way forward. Some tenants will have to hand their keys back. Others may obtain rent cuts by giving a slice of the upside to the landlords, perhaps even offering a stake in the operating business.
And what of the other themes from the event? The next four all relate to how businesses can adapt to the new operating environment and survive.
The emergence of hybrid concepts is certainly one way forward. Blending asset classes enables owners and operators to maximise the potential of individual properties. Easier said than done, of course, and it requires an imagination from regulators, notably planners, that has hitherto been absent. But if it is to happen, now is the time.
A theme feeding directly into the landlord and tenant debate is the notion of “putting more into the hopper to get through the crisis”. All sides will have to contribute. If occupiers have run out of cash then they will have to share upside.
The final two themes that came out were classics of modern business school textbooks: the need to reassess business models and the need to have a story. And this last point should be emphasised. It is what has driven the success of the tech industry and it is what can help the new ideas and entrepreneurs who will emerge out of this crisis from within operational real estate.