Landlord/Tenant Relations: The Pandemic Effect

Posted by Re-Leased on 17th December 2021 -

'How has the pandemic affected commercial landlord and tenant relations, and what will be the lasting impact?

This was the topic of discussion at a Re-Leased roundtable which exposed a variety of different experiences and the nuances of leasing and asset management strategies.

There is no doubt that the Covid 19 virus has created challenging market conditions for the property sector; from satisfying e-commerce demand for warehouse space to tenants struggling to pay rent because their businesses weren’t allowed to operate.

A number of support measures for business were introduced, including a moratorium on evictions which is still in place. The spotlight on landlord and tenant relations has never been as focused.

So, what was the initial impact?

After the shock of the first lockdown, the acceleration of online shopping and delivery bolstered demand for those operating in the distribution sector. Julian Carey, Managing Director, Industrials REIT, said demand continues with inquiries 50% up in 2021 compared to 2020.

However, the mandate to work from home meant tougher market conditions for those with office assets. Restrictions lifted in the Summer of 2021, and there has been an uptick in demand – “it’s not all doom and gloom” is how Ned Williams, Director at Evans Randall, described it.

Office churn

What is different is the level of churn, with more companies exercising break clauses.

“There is uncertainty as to what [office] space they want and how they come back, and I think it’s going to be a while until it settles down,” said Samantha Sherrard, Head of Commercial Estates Management, The William Pears Group. “That will last probably until the middle of next year, depending on how this winter goes and how businesses settle back into the work environment.”

Demand for flexible space has helped WeWork, which had a record Q3 for leasing. David Kaiser, Head of Real Estate, said tenants are testing out space before making bigger commitments. Goldman Sachs deal at WeWork space in Birmingham illustrates the trend; the bank took a floor on a 2-year lease with an option on additional floors, which was exercised within three months.

For the retail and leisure sector, which has arguably been the hardest hit, the pandemic has spotlighted different business strategies and the use of space to maximise value.

Neil Chatterton, Managing Director, Caxtons, gave the example of a building in a South East town centre vacated by a high street pizza chain. It was leased by a small operator which added a record shop and radio studio to the existing restaurant and function room. This has given it operating hours from breakfast right through to early morning.

It is a case of necessity breeds invention on the high street, and there are more tests to come – and not just for retail landlords. The moratorium on evictions ends in March 2022, and the Government has introduced a legally binding arbitration scheme to deal with arrears.

What was clear from the discussion that taking a proactive approach and engaging with struggling tenants has generally been positive.

WeWork’s Kaiser said it highlighted that landlord/tenant relationships are more than just rent collection: “I feel like my relationship with our landlords has never been stronger; they’ve never understood our business better, never been more interested. You find such synergies and opportunities with people when you talk.”

Helen Shellabear, Managing Director, Shellwin, Real Estate, agreed and said it had brought landlords and tenants closer together, generating goodwill which reflects positively on the level of occupancy.

But not all landlords are in a position to negotiate if they are heavily financed, for example, or manage assets, for certain types of investors. AEW invests on behalf of pension funds, and Managing Director Rachel McIsaac said that restricts what they can do: “It’s pensioners money you are potentially giving away.”

Competitive advantage

For the office, retail and leisure sectors it has become a tenants’ market in some locations with more space to choose from. So what are landlords doing to stand out from the crowd and secure deals?

One approach is to simplify the leasing process, make it quicker and transparent. This helps the tenant and the landlord and will become more critical with shorter leases and churn.

It is something Industrials REIT already does, Carey explained: “You need to be really cheap when it comes to renewing those leases. The smart lease that we have - our frictionless lease - cuts on average six weeks out every vacancy.”

Lease negotiation can set the tone for the landlord/tenant relationship, and a good relationship can speed up the letting process. Meanwhile, tough business conditions have meant more scrutiny of leases.

Shellabear said property marketing needs to be clearer about what is included and what isn’t so that tenants can make more informed decisions. Otherwise, there is a danger that space priced to include other costs can be dismissed because it ‘looks expensive’ compared to when just the rent is advertised.

Could landlords also differentiate, and generate revenue, by providing more for tenants? Sam Caulton, Chief Financial Officer, Re-Leased believes there is an opportunity from providing a menu of services for tenants. He said: “If you fill your building with additional services, there’s a subscription model you can introduce on top of the rent and standard service charge.”

As tenant demands change, are the metrics for measuring success in real estate changing?

The consensus was that the total return is still an important measure, particularly as it enables comparisons across asset classes for investors with mixed portfolios. The need for a return on investment hasn’t changed.

However, ESG is becoming an increasingly important consideration. Businesses are more knowledgeable about sustainability and may have their own environmental targets.

Sustainability measures and costs

The energy efficiency of buildings is a well-known measure but not all sustainability features are as easily measured and valued, for example, using environmentally friendly materials. And such features often come with a higher price tag than what has traditionally been used.

As a growing issue, the view was that sustainability would start making some buildings harder to let and potentially obsolete as the drive to reach net-zero carbon targets continues.

Shellabear said she is looking at where tenants can be brought in to help with the cost of making buildings more sustainable: “It shouldn’t just be all on the investor, but ultimately, it's a question of making sure you're ahead of the [sustainability] curve.”

And Carey admitted he’d thought long and hard about renewing his business’ office lease because the building isn’t grade A.

ESG is a new level of risk that investors will need to assess. The most sustainable buildings may well secure higher rents – a ‘green premium’ - but how far should asset managers go with ESG? For example, do landlords start assessing the ESG credentials of potential tenants before agreeing or renewing a lease?

Industrials REIT already has a red list of tenants that it won’t lease space to, for example, businesses involved in weapons. Carey said: “That list doesn’t yet include high polluters, but it will.”

It was agreed that ESG measurements are at an early stage of development and will get refined over time which will help both landlords and tenants.

ESG was something the property market was already starting to grapple with before the pandemic but that doesn’t mean the Covid crisis hasn’t left an indelible mark on the property sector.

Taking part in the discussion:

Laura Turner, Director, Helix
Ned Williams, Director, Evans Randall
Helen Shellabear, Managing Director, Shellwin Real Estate
Samantha Sherrard, Head of Commercial Estates Management, The William Pears Group
Robert Stark, Senior Executive, Director Property Management Strategy & Operations, Mapp
David Kaiser, Head of Real Estate, WeWork
Rachel McIsaac, Managing Director, AEW UK
Brent Evans, Director, BDE Consulting
Julian Carey, Managing Director, Industrials REIT
Neil Chatterton, Managing Director, Caxtons
Sam Caulton, Chief Financial Officer, Re-Leased
Alex Wilson, Commercial Property Strategist, Re-Leased