Home » Legal Help » Shutting up shop | Feature

Shutting up shop | Feature

The low down

Covid-19  has brought unprecedented challenges for the main actors in commercial property – from landlords and tenants to investors, developers and lenders. All are struggling with judgement calls. Should landlords insist that rent due must be paid in full, protecting their own staff, or is sharing the burden the right thing to do? And as clients confront a crisis worse than the 2008 crash, their lawyers are also under immense pressure. Transactions are on hold and staff have been furloughed en masse. But not everything is new. The pandemic has simply accelerated many existing trends in sectors such as retail. So, unusually, the long-term in real estate seems easier to predict than the short-term.

When the World Health Organization declared Covid-19 a pandemic and many countries, including the UK, implemented strict lockdown measures, Green Street Advisors, a US commercial real estate research group, predicted: ‘A historical deep recession is now coming. Even if it is short, it is likely to be painful, and risks have grown that it could create a financial crisis.’

Commercial real estate firm CBRE’s outlook was no less pessimistic. In a briefing at the end of March, Jos Tromp, CBRE’s EMEA head of thought leadership, predicted a 2.5% decline in GDP in western Europe this year, with ‘a weak Q1 and a brutal Q2’.

On a positive note, Tromp said governments in Europe were acting ‘much more quickly than during the financial crisis’, with a combination of monetary support, fiscal measures and loan guarantees.  

Legislation has developed rapidly across all countries. In the UK, new measures came into force on 25 March as part of the Coronavirus Act 2020. These included protection from eviction until 30 June for commercial tenants that cannot pay their rent because of Covid-19.  

Not all asset classes have been affected in the same way: retail, which was already struggling before the pandemic, has been hit the hardest.

Richard Vernon, a partner and head of the real estate department for EMEA/US at Ashurst, says the effects of confinement measures on the real estate market ‘continue to bite and the longer the lockdown continues, the more we will see the impact’.

This includes investors’ ability to raise capital, borrow, or service existing debt. Investors may need to consider whether they need to offload real estate assets.

As for commercial tenants, Vernon says: ‘The March quarter day for commercial rents was a huge issue, with many tenants choosing simply not to pay and many others requesting rent holidays, deferred rents and instalments.’

Farrer & Co partner Mark Gauguier says that at the heart of the current uncertainty are the short- to medium-term prospects for existing tenants and the wider letting market.

Landlords are faced with a Catch-22: to gamble and risk voids or stick with the sickly birds in the hand

Mark Gauguier, Farrer & Co partner

‘While tenant defaults are highly likely, the reduction of the pool of prospective tenants means that landlords are faced with a Catch-22: to gamble and risk voids or stick with the sickly birds in the hand,’ he says.

That was reflected in landlords and tenants ‘striking deals’ across the UK as March quarter loomed. ‘Some compromises reached are becoming increasingly creative,’ he says. These include ‘rent holidays, rent freezes, and rent-frees’. This, he believes, will enable the market to pick up again once the immediate crisis has subsided.

Gauguier adds: ‘Savvy, well-capitalised investors can act with magnanimity and offer businesses a certain latitude in return for an improved tenant package and longer lease terms. The market may well look slightly different when the dust settles, and tenants will be wary to protect against getting caught out in the future. But there is no reason to believe it won’t bounce back, as it always does.’

Litigation is not the solution

Ashfords legal director Paul Olliff highlights provisions in commercial leases in the food and drink industry that will be highly relevant in the Covid-19 crisis.   

For example, the definitions in a lease will determine whether the virus affects the landlord or the tenant.  ‘Turnover rent’ – a rent calculated based on the turnover generated by the tenant’s business at the premises – is common in the retail sector and benefits the tenant.

However, Olliff says the situation for tenants is ‘bleaker’ if the lease includes a flat annual rent with no reference to turnover. ‘The impact of reduced footfall [the number of people entering a shop in a given time] directly impacts upon a location’s profitability, as the fixed cost rent does not alter, despite the reduction in revenue due to a reduction in trade.’

Commercial tenants should also look out for force majeure clauses, which stipulate that if a specified event occurs that prevents one party from carrying out its obligations, the contract can be terminated or the performance of it delayed or suspended.  

‘Force majeure clauses are no longer common practice, but may be in older and long-term leases,’ says Olliff. ‘Whether force majeure would cover the spread of Covid-19 would turn on the facts: a careful consideration of the clause would be needed, coupled with a review of the international prognosis.’  

 A pandemic is not a ‘specific event’ and so it may be difficult to establish that Covid-19 is a force majeure event. But in a ‘full-scale’ lockdown, there would be a stronger basis to argue that force majeure has taken place and thus should result in rent suspension.

Tenants should also consider any relief or recourse under ‘uninsured risks’ clauses in their leases, as well as ‘more subtle common law duties’. But Olliff advises: ‘In these extraordinary times, co-operation and rent/services charge holidays or suspensions are the solution, not litigation or forfeiture.’ 

Lease lengths have been reducing for many years in response to continued market uncertainty. That started with the global financial crisis, which brought ‘a sea change’ in respect of short leases and break clauses, which are ‘absolutely routine at present’, says Nina Wilson, a partner at Wilson Browne Solicitors in Northamptonshire.

But she argues that the impact of Covid-19 will be still more profound. ‘Leases with a long rent-free period to allow for refurbishment are still progressing, but other leases are grinding to a halt,’ she says.

Asked whether the crisis would affect leasing structures and push occupiers to even shorter arrangements, CMS partner Ciaran Carvalho says that even before 2016, businesses were already opting for shorter leases ‘as workplaces become more agile and technology continues to play an ever-more important role’. He points to WeWork and IWG International as examples.  

Suzanne Gill, a partner at Wedlake Bell in London, says: ‘The Covid-19 challenges will operate to exacerbate trends we’ve seen in the market for a while.’

First, it will further diminish the cultural bias against remote working.

‘We’ll see more task-based layouts in offices: specific social space of various kinds – for example, meeting rooms, coffee spots and soft chairs – but also quiet space for solo work such as writing a report,’ she says.

‘Retail winners will be the large supermarkets who can scale up and deliver, and the independent retailers who can gain customer loyalty,’ Gill adds, emphasising this is a trend long predating the pandemic.

Turnover rents are interesting in this context, she stresses: ‘At the moment, the turnover element tends to be about 10% of the rent due. In tough trading conditions for shopping centres, big retailers can negotiate to push that percentage up because the shopping centre needs to keep as many stores occupied as possible’ (see box above).

E-commerce has driven a surge in demand for logistics real estate and the lockdown has accentuated this trend. ‘As we move to more home delivery, in the medium-term, we expect more demand for logistics units or sheds,’ Gill says. ‘These are hi-tech inside, and popular investments for pension funds because the tenants tend to like a rent linked to inflation, not the rental market. As the population ages, pension funds need to generate a steady yield rather than huge growth.’

‘Some areas in the sector are faring better than others – demand for logistics remains strong,’ Carvalho agrees, adding: ‘The big story for the real estate sector continues to be the rise of “alternatives”.’

Active management and operational property assets such as senior living, student accommodation and nursing homes are increasingly popular, with investors seeking higher yields and responding to the lack of traditional assets in the market, he says. Another asset class that has benefited from the demographical shift towards urbanisation in key cities is ‘co-living’ – shared housing for people with shared intentions.

Chris Luck, a partner in the funds and indirect real estate team at CMS, says ‘launching any real estate fund at the moment probably has a bigger market picture to work out’. But he adds: ‘We are still seeing healthy levels of activity, despite the uncertainty. Many managers and investors typically look ahead for the longer-term. Pricing may be an opportunity for some, international money still needs to be deployed and there is a shortage of supply of some assets such as new homes.’

What about real-estate transactions and development projects? ‘Some transactions are proceeding, while others are being renegotiated or put on hold for the time being,’ says Carvalho. ‘Development projects, while paused due to government guidance about self-isolation and social distancing, generally look set to continue when there is a return to more normal conditions.’

Vernon’s analysis is slightly different: ‘A massive issue has been the operation of construction sites and mixed messages from the government about whether these should be shut down or not, how workers can be kept safe, and the practicalities of social distancing on a construction site.’  

As an increasing number of construction sites are either shut down or closing, this ‘raises questions around force majeure and who takes the delay and cost risk of ceasing construction’, according to Vernon.

Vernon expects project delays and contractual disputes, and the possibility of counterparties seeking to rely on force majeure clauses or other contractual rights for relief from the performance of contractual obligations due to the virus outbreak.

If the restrictions carry on until September, then it seems extremely unlikely we will be able to restart as if waking from hibernation

Richard Vernon, Ashurst

As stores were forced to close down during the lockdown, ‘sadly, the risk of insolvency is now a reality, especially in the retail world, so we expect to see more cases of administrations and CVAs [company voluntary arrangements],’ Vernon notes.

Take Debenhams, which has filed for administration for the second time in a year. But this is another example of how Covid-19 is accelerating existing issues. In 2018/19, insolvencies in the sector hit a five-year high and were 31% higher than in the year before Brexit, Insolvency Service statistics show.

It is not just the clients who suffer from the knock-on effects of the lockdown measures. Speaking to the Gazette in early April, Wilson says: ‘Over the past week or so, we have put some of our fee-earners and support staff on furlough.’ That primarily affects residential conveyancing, but also commercial property, as well as office juniors and receptionists, because clients are not going to its offices.

‘We may need to commence a further round, if there is no end date in sight,’ Wilson says, adding: ‘If the current restrictions are relieved in the next month or so, then I would hope that the impact could be fairly short-lived. If the restrictions carry on until September, then it seems extremely unlikely we will be able to restart as if waking from hibernation.’

Wilson says while an ‘intense but short break could be dealt with, anything else is extremely worrying’. 

The pandemic is also having an effect on solicitors’ checks and controls on clients: ‘Anti-money laundering concerns are just as relevant, but harder to satisfy,’ Gill explains. ‘At Wedlake Bell, we are looking into facial recognition technology to help in situations where potential clients can’t come and see us or another professional, but where we still need to satisfy ourselves that a passport photo is a true likeness of the relevant individual – some of the challenger banks are using this.’

Even in these testing times, Gill warns that anti-money laundering laws will continue to have ‘a growing impact on all those involved in commercial property’. Professionals need to understand that know-your-client obligations extend beyond proof of address to understanding source of funds as well. ‘Otherwise, you might find you’re acting for a drug dealer who happens to pay their gas bill on time,’ she says.

Gill urges managers of law firms to work to effect a change in culture. ‘If solicitors, especially partners, are remunerated based on the work they bring in, they’ll be motivated to turn a blind eye or take shortcuts,’ she says. At her firm, Gill must report annually on work she has turned away each year, whether because it is too specialist or because the potential client has not given sufficient answers about how they have generated wealth.

‘Real estate has been and continues to be the sector most favoured by money launderers seeking a clean market for their illicit wealth,’ warns Vernon.

Empty-immigration

Immigration and slavery

Covid-19 will affect the mobility of workers across the globe for a lengthy period. However, many employers were already concerned about the implications of Brexit for free movement and access to labour, and the resulting effects on the real estate and construction sectors, says Kirsty Cooke, senior associate at Ashfords.

From 1 January 2021, EU and non-EU citizens will be treated equally by the UK if they intend to relocate here to live or work. The revised points-based immigration system focuses on prioritising access to the UK and its job market for highly skilled workers and reducing the number of lower-skilled workers. Cooke says that while its impact on low-skilled labour is widely recognised, there may also be ‘unintended consequences’ for professionals in the real estate sector.

To deliver major infrastructure projects, the UK relies on professionals from the EU. ‘Many of these migrant workers are self-employed contractors, such as architects and project managers, who work for a number of clients at the same time, but are critical to project delivery,’ Cooke says.  

The revised system will require a job offer from an employer, which will act as the immigrant’s sponsor. ‘This process does not cover people working or providing services on a temporary basis in a self-employed capacity doing highly skilled roles,’ explains Cooke, recommending that employers start planning now to mitigate these risks.  

Tens of thousands of people in the UK are subject to modern slavery, it has been estimated, and that is ‘particularly prevalent’ in the construction sector, according to Cooke. Under the Modern Slavery Act 2015, organisations with an annual turnover of more than £36m are obliged to produce a transparency statement every year that details the steps they have taken to ensure that slavery is not taking place in their business or supply chains.

But Cooke emphasises the importance for all organisations of taking ‘practical steps’ to tackle modern slavery to avoid ‘reputational damage’.

That includes carrying out proper due diligence of suppliers and contractors, and training employees how to recognise modern slavery, as well as introducing policies or updating contracts with suppliers that require them to commit to eradicating modern slavery in their own business and supply chains.

Unexplained wealth orders (UWO) – court orders requiring an individual to explain the source of their wealth and how assets were acquired – were introduced in February as part of the Criminal Finances Act 2017 package of measures to increase the fight against corruption and money laundering.

Vernon says there has been a ‘notable’ increase in action by the National Crime Agency in seeking and obtaining UWOs. For example, in July, the NCA obtained the first UWO related to serious organised crime, compelling a businessman to reveal the source of his £10m property portfolio. Meanwhile, in February the Court of Appeal dismissed an appeal by the wife of an Azerbaijani public official (and convicted fraudster) against a UWO related to her £15m home in London (see update, p28).

The NCA is also increasing in sophistication by combining different forms of civil asset freezing and recovery orders, and interim orders to get at real estate assets.

‘The NCA and the new National Economic Crime Centre are talking more bullishly about the appetite to investigate money laundering in the property market,’ Vernon says. This means more and higher-value cases brought this year.

Property management businesses will also need more support from lawyers on compliance with the General Data Protection Regulation (GDPR). Take the €14.5m GDPR fine levied against Deutsche Wohnen in Berlin last October.

‘What starts in the EU doesn’t end in the EU and we still have to follow EU regulations – at least until the transition period ends,’ points out Philip Olmer, managing director of Compliance on Demand.  

‘Many businesses operating commercial property may not consider GDPR to be a major issue,’ says Farrer’s Gauguier. ‘With the increase in mixed-use and PRS [private rented sector] schemes and with large companies now more likely to manage individual tenancies directly, the industry needs to be more aware of the severe penalties that can be imposed.’ 

Property management companies may handle personal data, such as tenant names, addresses and bank account details, as well as potentially more sensitive information where they obtain documents to comply with the immigration checks required as part of the ‘right to rent’ scheme in England, Gauguier explains. While the GDPR applies to the UK until the end of the transition period, the government plans to introduce a ‘UK GDPR’ which is likely to be similar.  

Commenting on the GDPR fine issued by the Berlin Commissioner for Data Protection against Berlin’s biggest listed landlord, Vernon says that although the fine is not specific to the property management sector, it is interesting because ‘property management companies tend to take the view that they process minimal data, but in actuality, the volume of data, based on their share size, is significant’.

Clare Harman Clark, a senior PSL in the real estate and construction group at Taylor Wessing, says: ‘Property ownership and management has always been a data-heavy exercise and, as the sector digitises, these data repositories are bulging.’

Many firms routinely deposit historic data in data graveyards, but simply archiving the details of years, processes and occupiers past is insufficient, she says. ‘The rights of those data subjects have been reanimated with GDPR.’

There is one further headache for commercial property lawyers and their clients. Taxation remains a fast-changing and increasingly complex aspect of practising in this sector. On 11 March, the chancellor confirmed in the budget the introduction next April of a 2% stamp duty land tax surcharge on overseas investors buying residential property in England and Northern Ireland. This is widely expected to lead to a flurry of activity before then. Vernon says that where contracts were exchanged before the UK budget, but are completed or substantially performed after 1 April 2021, the surcharge may not apply.

Lawyers can predict much of what comes after the Covid-19 pandemic and the immediate effects of lockdown – the difficulty comes when judging what happens to their clients and their practices in the meantime.

 

Marialuisa Taddia is a freelance journalist


Source link

About admin

Share a little biographical information here to fill out your profile as the author. Just fill the "Biographical Info" form in the User Profile section in your Dashboard. Also... use your email that connect with Gravatar, so your pict will appear in the left.
debt collecting

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

Scroll To Top