A win-win solution to the commercial rent crisis
By Andrew Purves and Josh Ryan-Collins
A dangerous game of chicken is taking place between commercial landlords and tenants in high streets, business parks and offices throughout the UK.
Today (24 June) is rent day, when businesses are supposed to pay rent for the next quarter. With many companies forced to close for three months with little or no income, few are likely to be in a position to make this payment. On the last rent day in March, landlords received only around half of the total expected rent, and are bracing themselves for even greater shortfalls today.
The UK government has legislated to prevent property owners taking action to wind up companies for non-payment of rent until 30 June, and indicated just yesterday that this will be extended to the end of September.
Assuming landlords will be able to pursue non-payers for rent arrears from 1 October, who will really want to force tenants out? Not only will there be a media backlash, and corresponding reputational risk, but it is unclear who will replace the evicted companies. Startups are often not welcome, given the lack of a trading history or ‘covenant’ to support their tenancy.
For how long will landlords exercise forbearance? Non-payment of rent will cause owners their own cashflow nightmare — especially those who are heavily in debt after years of borrowing at ultra-low interest rates. On top of this, property values in many sectors have fallen, especially in retail. There is talk of many companies reducing their occupancy of actual buildings, particularly offices, which may start to look like an excessive expense when people can work just as efficiently at home. This could breach loan to value covenants agreed between banks and landowners.
Media reports suggest tenants are calling on landlords to agree to reduce rents based on turnover, or threaten company voluntary arrangements (CVA) to escape non-profitable leases.
A collapse in the commercial real estate sector could have damaging economy-wide impacts. Banks, pension funds and life insurers are among the groups holding commercial mortgages and exposed to any potential defaults.
A win-win solution?
HM Treasury and the Bank of England have moved impressively fast to support businesses in distress with the Job Retention scheme and various lending facilities. But these programs are temporary, with the hope that things will rapidly return to normal. But with two, three or four months of no income, many companies will never recover the lost cashflow.
The government has guaranteed many of the emergency business loans. However, if a company’s directors believe that such loans cannot be repaid, they will cease to be going concerns, auditors may qualify their accounts, and they will be forced to cease trading. A gaping hole in income is partly offset by reduced variable costs of sale, such as supplies, heat light and power, etc. But the fixed costs of business remain the same: most notably rent.
One way of permanently reducing the rent problem would be for the Government or Bank of England to buy up commercial land from distressed landlords who would receive a long lease to operate or develop buildings on the land, in return for an annual payment on the rental value of the land. As with Quantitative Easing and the recent Covid Corporate Financial Facility (CCFF), the Bank of England could hold commercial land assets off its own balance sheet in a discrete entity with the assets underwritten by the Treasury to protect the Bank.
Valuations could be made to separate land value from building value, and the National Valuation Office would be required to maintain this register with new assessments of value every two years. Big data and AI are making accurate estimates of land value a much simpler activity. In March this year, HM Treasury floated the idea that land value could be used as the basis for valuation in proposed reforms to Business Rates. Property taxes are already assessed on land values in Denmark, New Zealand, the United States and Canada.
The Bank of England could then offer a year’s holiday on the payment of the annual rent, as long as the erstwhile landowner passed on this rent holiday to their tenants. This would give all parties time to recover their cashflow, and adjust to the new normal. After twelve months, landowners would continue to charge the agreed annual rent to their tenants.
Commercial leases are often written with a five year ‘upwards only’ review clause. Assuming the value of the land increased before the five-year review, the landowner would have to pay the higher land value element to the Bank and would not be permitted to pass it on to the tenant. The first payment for the land rent would be payable after 12 months — annually in arrears, rather than quarterly in advance.
The Bank of England, for its part, having created new money to purchase the land, would retain the land value as an asset — an asset arguably more secure than the unsecured commercial paper and corporate bonds issued by companies qualifying for the CCFF. So far almost £18 billion has been issued by the Bank of England via this scheme. The Bank in turn will be able to pass on this annual land rent to the government to fund the recovery from Covid-19.
Commercial owner occupiers could be given the same opportunity to sell their land to the Bank, and receive an interest free injection of capital into their business. Once again, the annual land rent would be paid after twelve months, while from this point there might be an option to pay monthly, for a small discount. They too, would become leaseholders.
In fact, in English Law, all land is owned by the Crown. The term ‘freehold’ is not absolute ownership, rather the right to occupy a piece of land free of any dues to the Crown. The effect of this scheme would be to re-introduce an annual land rent in return for the security of tenure granted by the lease. The occupier would continue to enjoy these rights in return for paying rent.
At some point, the scheme could be reversed — with the leaseholder required to pay a new lump sum to the Bank, for the ‘freehold’ at a value to be assessed at the time of the payment. Most likely, this would be in better economic times, which would of course mean higher land values and a decent return for the government.
Alternatively, the government might wish to consider shifting towards a permanent commercial property leasehold system as a means of capturing the economic rent from land value appreciation for the public purse. A number of Asian economies, including Singapore, Hong Kong and South Korea operate commercial leasehold schemes and retain public ownership over commercial real estate. This brings in significant development revenues and enables more strategic planning in support of industrial policy.
Implemented effectively, such an approach would be a win-win for all stakeholders involved. The pressure on commercial landlords and tenants would be eased, while the risk of financial instability would be significantly reduced. Taxpayers should also benefit in the long run.
