Where commercial leases are at?

Commercial leases in a post covid world are going to be a mixed bag of outcomes and for landlords that are unwilling to bring a commerciality to their positions it becomes practically untenable, as there is significant upheaval in several sectors and there is no clarity as to how 2021 will run for business that may already been under pressure.

For office style businesses, there is a plethora of empty space and this will continue as the work from home phenomenon continues, this has commenced prior to covid, but in the continuing changing world, it is clear that this will continue to expand. Shared tenancies and flexible workspaces will continue to be the normal rather than the unique.

For landlords it is beneficial to understand that the world has changed and that the old approach is simply not going to work as it has in the past. Where locations are thriving this has been through a collaborative approach between the landlord and the tenant, where this has not been the case, generally we are seeing a hostility or aggression, and an unwillingness to forge solutions.

A vacant location?

Working with both sides of the scenario, there is an acknowledgment that vacancy is not in the interests of anyone. Where a site becomes empty, problems begin for the entirety of the area, and it reduces foot traffic, in the case of office space can make it feel deserted and unwelcoming. Understanding that there are economic considerations coupled with commerciality, we are noticing businesses heavily focusing on the bottom line and cost rationalisation has been a key aspect of this.

We have covered the concept of zombie locations, that where the businesses that remain are in a state of animation to try and have some form of survival. In the restructure space in particular this means that businesses need to not only consider their own outlook but those of the businesses near them and identify what is on the horizon.

A strategic partnership?

Landlords need to be realistic when it comes to the viability of the underlying business, if the tenant is only working for the landlord then the reality is that the site will become empty, we have often articulated that for small locations the loss of a tenant can be devastating for an entire strip, and where that tenant is a drawcard or brings additional consumers, it is timely to have a commercial approach to negotiation. We often open the discussion with what is the profitability of the business and is it worth continuing to operate, often times it is the business that is merely open for the payment of rent, and at this stage there needs to be a commercial analysis.

Where the tenant and landlord relationship are forged in a mutually beneficial commercial outlook, then there are many opportunities for a result that both sides can be happy with. Where one side is significantly disadvantaged, then there is unlikely an option that will be sustainable in the long term.

Prior to Christmas we assisted a business where the landlord demanded an 80% rent increase over the next 6 months for a new lease, we were dumbfounded and articulated that the business, a gym, had three months of complete shutdown and significant additional membership loss and was getting back on its feet, the response… “not my problem”.

The solution was that the lease would not be renewed as there was a location within 200m of the current site, similar parking and had been vacant for a significant period, where the incoming landlord was willing to work with the business, to the extent of creating a secondary sub-tenancy and installing a small cafe. For the business this was a reduction in head-rent by almost 50% and a landlord that understood that the underlying business needs to be viable for the landlord to have a permanent tenant.

The penny dropped for the current landlord, where now facing an empty building they are wanting to come to a commercial agreement, the phrase “not my problem’ was dropped as the lease termination was handed over. Hubris and animation dropped as they are now wanting to work together for a commercial outcome. A scream of “I was happy to work you” was the final word as a long term tenant departed and an empty shell would remain, where the advertised incentives are already over six months and a head rent reduction of 25%.

Tips for Negotiation

1. Understand your position

Too often we assist businesses that have started negotiations without understanding the status of the business. The business may be uneconomic or unprofitable regardless of the rent, and it may be time for a different approach, rather than just re-negotiating the rent. As business advisors and accountants we recommend that prior to any interaction with the landlord it is important to understand your financial position, how your business is trading and what you are actually trying to achieve.

2. Be upfront

Now is not the time to be timid, if you want to renegotiate your lease being on the front foot will place you in a better position. Open a dialogue as soon as practical, have an agenda and make sure that the approach is made to the right person. Whilst you may generally deal with the leasing agent, often times it is better to go straight to the source and have the conversation without an intermediary.

3. Be commercial

Remember that unless the location is unique there are alternative options but equally what needs to be put forward should be a commercial option for the landlord. If the proposal is clearly uncommercial then there is no incentive for the landlord to accept a proposal, equally it needs to be commercial for you as well.

If you are putting forward a position for a substantial reduction or change in terms, make sure that it is palatable, whether it is an increase in lease term, flexibility for change or use, or an alternative use which will assist the landlord for future improvement. Equally undertakings for capital expenditure may make the proposal more reasonable.

4. Know the market

It is important to understand the market and what you are proposing, this is not only understanding price, but also what is going on in your immediate area. Whilst rents may be declining there may be a reason for doing so, equally if the location is struggling overall, it may be an indication that whatever the proposal is may not be best for your business.

An approach would be to contact local agents and test the market for a relocation.

5. Have a solution

Whilst rent is important, other issues may be equally important in the development of a long term rental arrangement. We have assisted businesses in negotiations that have results in improvements to the premises in line with rent negotiations. Items such as solar, new branding or site improvement may be as beneficial as a rent reduction, and demonstrate a long term commitment to the premises from both the landlord and business owner.

In understanding what your business needs, align this with the premises. The old position that the tenant is responsible for everything has changed under the post covid dynamic, and it is not unreasonable to expect your landlord to make additional contributions to assist your business through.

In working with a motel tenant the underlying business could not continue in its current format without significant cost reduction and a change of the terms. We determined that the motel could no longer offer a food and beverage operation (as required under the lease), was unable to adequately offer liquor (another condition under the lease), the pool was simply a sunk cost and the electricity cost was prohibitive. A proposal put forward to the landlord was that the motel business could be rationalised and that the landlord would cover the cost of the removal of the pool and installation of solar. The landlord would be able to offer a standalone lease on the restaurant and a previously operated (but now unused) function centre could also be leased as a 24 hour gym to a separate operator. For the motel operator this allowed the business to move into profitability, for the landlord this provided two additional revenue sources that has retained the value of the property.

6. Know the cost of moving

Its okay to threaten to leave but be prepared that they may accept your threat, if this is the case you need to move.

Some businesses are easy to replicate, others this may be a significant impost.

7. Be happy to walk

If the rent is not conducive to making a profit then it is time to walk from the premises. Remember that you are operating the business for your own reasons and not just to be paying the rent.