Britain’s councils look set to increase their exposure to commercial property investment at a time when many, especially those with retail tenants, are looking to exit.
With budget cuts and the effects of austerity biting, they need to find alternative revenue streams to prop up creaking services and record-low interest rates have steered many to commercial property, whether it be office, industrial, retail or hotels.
Warrington Borough Council made its intentions clear with a massive £211m investment in Birchwood Business Park last year and according to reports Southend has announced it has set aside more than £20m for commercial property purchases over the coming three years.
Hambleton in the North East has just earmarked £40m for this purpose and Reading has invested more than £42m on three commercial properties over the past two years. Spelthorne alone has spent in the region of £270m. There are many more. Council borrowing has rocketed to £10bn from £4.4bn four years earlier. Whilst some sectors of commercial property continue to offer relatively low risk investments, the same cannot be said of retail.
Britain’s High Streets are in flux and even out-of-town parks are plagued by high-profile collapses. Despite more than 2,100 stores and some 40,000 employees being affected by retail failures last year alone, many councils still consider the gamble of retail property investment a risk worth taking.
However, the alarm bells should now well and truly be ringing after the Royal Institution of Chartered Surveyors (RICS) issued a warning in January this year that the valuations of shopping centres could be slashed after property agents were ordered to reflect the havoc in the retail industry.
The guidance comes as bricks-and-mortar retailers are finding themselves facing high rents, higher business rates and under-performing store space threatened by online-only retailers who don’t have the same business threats. Almost one third of clothing and homeware products are now purchased online, unthinkable when many of these retailers originally took out their long and expensive leases.
And now many retailers want out – and a legal mechanism, a Company Voluntary Arrangement (CVA) is allowing them to do this.
CVAs are on the increase. A CVA allows a company to address its financial difficulties and settle debts by coming to an arrangement with its unsecured creditors.
Some major household names, including Mothercare, Poundworld and House of Fraser have all recently entered into CVAs which allows them to try and trade out of their difficulties or to secure a more equitable distribution to creditors than might have been achieved through other insolvency processes.
If a retailer ‘comes to an arrangement’ with creditors, what’s the problem? Well, the CVA arrangement needs only to be with 75% of creditors, meaning landlords are often bound by its terms regardless of whether they voted for or against it or were even notified of the vote at all, due to the value attributed to their interest in the scheme.
And with only 28 days and limited grounds on which to appeal, many landlords are facing serious threats to their rental incomes. One such ground is a claim for unfair prejudice for unequal treatment of landlords. However, this has yet to have been used as a challenge to a CVA.
If you’ve got this far and are still considering retail property investment for your authority, my strong advice would be to sit tight and adopt a patient wait-and-see policy before committing to retail property investment.
For those who have already taken the plunge and own retail property and are faced with potential CVAs, what can you do?
Act fast! If you suspect your tenant may be about to go into a CVA you should take immediate early advice on your position, options and strategy. A CVA won’t wait for you and it is worth remembering until a CVA is entered into, a landlord can pursue any available remedies.
There are a number of options available to a landlord, all of which will be painful but should give you the best chance of salvaging something from what will be a difficult situation:
1. Rent reduction
Landlords might decide to reassess their flexibility when it comes to reducing rent. Reducing their rents and avoiding large annual increases would benefit the retailers and, in turn, their landlords.
Retailers may try and have a ‘CVA clause’ added into their lease agreement, whereby they will be able to renegotiate their rent and agree rent reductions on stores where a neighbour receives a similar deal through a CVA (and Next has asked for this in their leases).
Landlords may be able to save themselves a complete loss of rent from their tenants and reducing rent may allow retailers to keep their stores open.
A well advised landlord may even be able to negotiate a stepped fixed increase rent provision, with triggers being the performance of the tenant’s store or overall business.
2. Turnover lease
This could be another solution to retailer insolvency and landlords being paid their rent. A turnover lease is a where the rent payable to the landlord is calculated based on the tenant’s turnover, including all profit made by the retailers both in and out of the premises (e.g. online sales). Tenants would be more likely to continue with their leases as the risk is shared with both the tenant and landlord equally, as are the benefits. If the tenant has a good financial year, the landlord will receive a better rent.
3. Monthly terms
Agreeing by way of a side letter that the tenant can pay the rent on a monthly rather than quarterly basis is another option. Renegotiating the lease in general could benefit both the tenant and landlord as it can make matters more manageable for both parties.
Changing the lease gives the landlord a chance to protect its rental income by keeping the tenant in place on a term and rent more manageable for them.
4. Lease amendments
Parent company or director guarantees are advisable for lease amendments, as is a large rent deposit which is kept topped up (although you may be restricted from accessing this once a CVA has been agreed).
It is important that both the landlord and tenant discuss matters as soon as possible to avoid a situation where a tenant becomes financially distressed and has no choice but to take advice from insolvency experts.
After a CVA
Whether a landlord can sue for rent following a CVA depends on the terms of that particular CVA.
In general, the landlord’s right to forfeit remains (unless the CVA specifically removes this right). There is also a specific exemption for small companies which is one that satisfies two or more of the following criteria:
- A turnover no greater than £10.2m;
- Balance sheet assets no greater than £5.1m; and
- No more than 50 employees
This is known as a moratorium, which means during the period which the moratorium is in place action cannot be taken and proceedings cannot be commenced against the company.
Moratorium rules will come into effect when the directors file a copy of the CVA proposal at court and will end on the day on which the CVA is approved/declined by creditors (subject to maximum period of 28 days which can be extended by a maximum of two months).
Where a CVA is in place, landlords will be bound by this and any rent arrears, future rent and other sums due under the terms of the lease will be fixed by the terms of the CVA (unless the terms of the CVA exclude those claims from the scope).
There is no power for a lease to be disclaimed by the insolvency practitioner in connection with a CVA.
Daniel Stern is an associate solicitor and specialist commercial property litigator at Manchester law firm Slater Heelis LLP.