Rarely a week goes by without some news headline or article about the decline of the High Street: lower retail sales, pressure on retail and leisure operators, shop closures etc. This results in the supply of retail and leisure space on the High Street exceeding the demand for that space. Basic economic theory then applies, with the result being that the ‘price’, in this case rent, reduces until it reaches the point that supply and demand meet i.e. at a lower rent that a tenant is willing to pay and a landlord is willing to receive.
If a landlord wants a tenant for a vacant unit, then the landlord is going to have to reduce the headline rent or offer substantial inducements (whether rent-free periods, capital contributions etc) to get a tenant to take that space.
But what about existing leases that were entered into a few years ago – where does that leave the landlord and the tenant? If you take a typical example of a 15 year lease with five yearly upwards rent reviews, then the best a tenant can hope for, even if rents are falling in that location, is a nil increase at each rent review, which of course means a reduction in rent in real terms. Landlords may be bullish in locations that are reasonably well let on leases with 10 or so years to run, although some may view that as being a ‘head in the sand’ approach to the issue.
What other options are open to existing tenants? Entering in to a Company Voluntary Arrangement (CVA) has become increasingly common, with many High Street names having entered in to a CVA over the last few years. The latest retailer about to do so would appear to be Jessops. One of the main reasons for entering in to a CVA is to seek to reduce the cost base for a company, usually by reducing rent (and sometimes commercial rates) and getting the whole body of creditors of the company to agree to a reduction in rent in some or all of the company’s shops for the period of the CVA (usually two or three years) to help turn the company around and keep trading.
The stark choice is for landlords to agree to the CVA and receive reduced rents or for the company to go in to administration or liquidation, resulting in a lower return to the landlords and an empty unit. One major criticism of CVAs is that they benefit companies that have perhaps been badly managed or have expanded too quickly and can’t service the debt that they have built up. If such companies enter into a CVA and can reduce their rent bill, then this puts them at an unfair advantage compared with other retailers operating from the same retail parks, shopping centres or high streets and paying the full market rent. This point has been made by a number of retailers, including Next, Primark and H&M, who are looking to introduce “CVA clauses” in to their new leases that would allow their rent to be reduced in line with rent reductions achieved by other tenants in the same centre if those tenants enter into a CVA.
Another option open to a tenant if they have break options in their leases, is to seek to exercise the break option (or threaten to do so) with the intention being that if the landlord agrees to reduce the rent then the tenant will renew the lease and stay in occupation after the break date at a reduced rent. The landlord can call the tenant’s bluff, but that runs the risk of having an empty unit that can only be leased at a lower rent anyway (as well as with the increased costs of finding a new tenant, agreeing lease terms, rent-free periods etc).
There are other ways for a tenant to reduce its property costs. Tenants are increasingly demanding service charge caps in retail parks and shopping centres. This puts the onus on the landlord to try and keep the service charge as low as possible. Tenants are also increasingly interrogating landlords on service charge, management fees and insurance premiums – putting pressure on landlords to try and demonstrate that they are getting the lowest premiums possible. This can save a large retailer with 100’s of units thousands of pounds every year.
Retailing will continue to change and evolve over the coming years. The problems of the High Street can’t simply be blamed on the rise of internet shopping, although that does play a part in some sectors. Issues such as the level of commercial rates need looked in to as retailers and leisure operators do appear to pay a disproportionately higher level of commercial rates compared to other occupiers of commercial property. Leases may need to become more flexible, with shorter terms and rent linked to turnover (although that doesn’t work for every business, particularly those with a high turnover but low profit model).
Some retailing sectors are doing well – discount retailers and retail parks are generally expanding – matching a profitable business model with modern low cost retail space that consumers like to shop in. It’s no surprise that good locations will attract successful retailers who will pay higher rents to be in those locations (and stay in them at lease expiry).
More innovative ways of using commercial property space or sharing it with other uses and attracting customers and the public to those areas may be the answer in some locations - but may not be the answer to the problems of every High Street in the country.