Shared & Halved - Focus on Investors

To support clients and colleagues working in the Real Estate Investment community, Shoosmiths hosted a webinar on 9th April 2020 looking at some of the most pressing issues impacting the sector in light of the unique challenges posed by COVID-19.

Introduction

The COVID-19 crisis is unlike any other we have faced as a country, presenting a new and varied set of challenges to UK and global businesses.

Based on what clients and contacts have told us is most pertinent to them in the current climate, we have devised a series of webinars to look at implications of the outbreak. In this webinar we looked at the Real Estate Investment community. Below are the key themes and takeaways from that session.

Industry trends / challenges

1) Investors are seeking to respond positively to protect businesses and jobs (in their own organisations and also those of their tenants) so that once the crisis is over normal operations (for all parties) can be resumed.

2) There is a need to protect income and asset value, whilst seeking to support tenants, where possible and commercially viable.

3) There are other competing interests including the need to comply with finance obligations and headlease covenants, and also provide essential services such as security, whilst at the same time seeking to reduce service charges to assist occupiers.

4) There is the need to safeguard relationships for the future and a focus on recovery for as many businesses as possible – there should ideally be no winners or losers from the crisis.

5) The Government has rightly focused on helping tenants but needs to be aware that landlords/investors are suffering too.

6) Cashflow is crucial. Other governments such as Denmark and Italy have introduced rental support for property owners, akin to furlough leave, where the government pays a percentage of the rent if this is unpaid.

Actions between landlords and tenants

1. There is emerging a “common purpose” between landlord and tenant groups to work together and find a way through the difficulties.

2. Landlords and tenants are looking for simple, quick and creative ways of reaching agreement.

3. We are seeing a number of different requests from tenants and landlord clients are having to deal with all of these, including:

• requests for monthly rents for those tenants paying quarterly;
• rent being paid in arrears rather than advance for a short period; and
• rent deferments and rent holidays.

The above can (if agreed) be easily dealt with via side letters, and many of these are personal arrangements. Landlords are generally seeking to agree these on a case-by-case basis. There are likely to be further discussions as we approach the next rent payment date (for the usual quarterly rent cycle) in June. Landlords are having to address these as tenants’ business change and are affected by the crisis, and also as the position regarding the government lockdown develops. Until we know when the lockdown will end, it is likely that this will be an ongoing situation for investor clients. There is a recognition that there needs to be some ‘give and take’ between landlords and tenants, meaning that we are also seeing tenants agreeing lease extensions and / or the removal or deferment of break rights in return for longer term rent holidays or deferrals. These need to be more formal and will need to be dealt with by reversionary leases / deeds of variation. Consideration needs to be given as to whether this is the right step if there are covenant strength issues or doubt over a tenant’s ability to survive.

The mini poll on our webex showed that that, whilst some landlords hadn’t made any concessions, moving to monthly rents and rental deferment arrangements were the most common concessions offered by investors – with a few instances of rent reductions (e.g. half rent only being paid by occupiers).

N.B.: Regard must be had to banking covenants and headlease obligations and whether consents are required to implement any of the above changes.

“Feedback from our members is that lenders are being understanding and supportive, which mirrors the general approach many of our members are taking to their occupiers. However, the proof will be in how long lenders continue to take that sort of supportive approach in the face of what is probably going to be a continued shortfall in income.”

 [Ion Fletcher, Director of Policy (Finance), BPF]

Pandemic drafting

1. We are starting to see requests for longer term lease amendments to cover further lockdowns / other pandemics, particularly where there are current deals ready to complete.

2. Lease drafting focuses mainly around rent suspension, suspension of certain covenants which cannot be performed, e.g. repair where there is no access available, relaxation to keep open clauses, reduction of services to essential services only and suspension of opening hours.

N.B.: Investors need to proceed with caution in reaching agreement on longer term lease changes such as these (whether personal or not), since, until the market settles, there can be no certainty as to what may / may not become standard drafting and institutionally acceptable / acceptable to lenders. The concern around agreeing long term provisions such as this is that this may result in leases being seen as defective (to some extent). However, clients are often faced with a choice of accepting this type of drafting, or seeing transactions delay or abort. In the current market, we are seeing some clients opt for the former.

The effect on current deals and the next 12 months: our poll results

Some transactions which were already under negotiation in February / March have made their way through to exchange / completion on the same terms (usually those which were well-progressed when the lockdown was implemented).

Many others have now been paused, with our audience indicating both short (3 month) or medium (up to 6 month) pauses on deals they were considering in February / March. 
Interestingly, our investor audience were looking to buy, hold, or redevelop rather than sell assets during the remainder of 2020 - a positive sign that investors expect to invest inthe right opportunities.

Which sectors offered the best opportunities in the next 6-12 months to our audience? Probably no surprise that logistics was the big winner here with our investor audience, building on the sector’s growth and strength in 2019 and early 2020. High occupier demand and (whether or not linked to our departure from the EU and the need to create buffer arrangements) and strong tenant covenants have worked together to make this the favourite.

Surprisingly, residential / student / PRS - the previously “hot” alternatives - didn’t make a showing in our poll - perhaps due to the lack of movement during lockdown. We still have a national housing shortage - and the current lockdown isn’t going to change that - so perhaps ‘food for thought’ here especially with non-student residential investments.
Finally, perhaps no surprise was that none of our audience felt that retail / leisure investment offered the best opportunity in the next 6-12 months. However, some retailers - especially those essential retailers or with a strong online presence will undoubtedly come out of this better than others and their covenants will be valued by investors going forward - but for many the retail sector is something which they don’t have any further appetite for at the present.

Legislative impact on legal remedies

We consider the impact of COVID-19 related legislation on the remedies normally available to commercial landlords below.

Forfeiture

• Landlords may not forfeit a business lease for rent arrears until 30 June 2020. This date may be extended. The right still exists but its enforcement before July 2020 is unlawful.
• Having discussions with occupiers and agreeing temporary relief concessions will not waive the right to forfeit. Only an express written waiver of the right will be effective.
• Landlords may not oppose tenancy renewal under s.30(1)(b) of the Landlord and Tenant Act 1954 (persistent delay in paying rent) even for ‘old’ arrears.

Guarantors / authorised guarantee agreements

• The legislation does not affect these rights.
• Landlords may look to guarantors and give notice to pay to former tenants under AGAs.
• Landlords should exercise caution when negotiating concessions with tenants to avoid any inadvertent release of guarantees.

Rent deposits

• The legislation does not affect these rights. Landlords may look to deduct arrears from monies held, subject to any specific requirements of the deposit deed.

Service charges

• Service charges are included in the definition of rent under the legislation. Accordingly, forfeiture for service charge arrears is unavailable until July 2020 (at least).
• We see potential for an increase in service charge disputes as to the level of services provided during a lockdown period.

CRAR

• This remains available as a legal remedy, however there may be practical difficulties, such as finding an agent willing to accept instructions, or selling any goods realised due to the forced closure of auction houses.
• Ordinarily, exercising CRAR would waive the right to forfeit but this appears to have been overridden by the legislation.

Insolvency / civil proceedings

• The legislation does not affect the right to bring proceedings, including insolvency proceedings. Civil claims, statutory demands and winding up / bankruptcy petitions remain available as a legal remedy.
• There is however potential for increased delay as the Courts grapple with remote hearings and new technology.

Since the webinar took place, the Government has issued further guidance stating that statutory demands may not be used in the period 1 March 2020 to 30 June 2020 nor may winding-up petitions presented on or after 27 April 2020 in respect of a company’s inability to pay its debts due to COVID-19. In addition, regulations have been issued restricting the use of CRAR to circumstances where 90 days’ or more rent are in arrears.

For further details of our future webinars please visit our Coronavirus COVID-19 hub here.