Let’s imagine you’ve bought a prime shop property let to a blue-chip multiple retailer on an institutional lease for term 20 years, with 5 yearly upward-only rent reviews to market rent and tenant break clause at year 15. The initial yield on purchase price is 5% net of costs. Buying for the long-haul involves a leap of faith so it makes sense to buy the best and to mortgage the purchase if not a cash-buyer. For borrowers, that the loan interest and associated fees/costs reduces the take-home yield is incidental: the psychological expectation of an increase at each rent review counteracts and property has a reputation as a long-term hedge against inflation. Owning the investment is likely to make you feel you’ve arrived.
Arriving is only the start. The plan is where to go, the strategy how best to get there. To end up owing a property that used to be categorised as prime because it was let to a blue-chip retailer is the stuff of secondary lots and decaying ’high streets’. The number of locations that are managing to grow is in decline. The rate of negative growth is accelerating.
Where to go depends not upon the general relationship between landlord and tenant but whether the tenant wants to be in the relationship with the particular landlord. Since the landlord’s interest in the property is a saleable (and mortgageable) asset, the value of the asset will attract predators. In property, a predator is an adviser and/or financier that wants to cash in on the landlord’s investment. The higher the value the more the lure.
Unlike the business-to-consumer (B2C) market which in property is represented by residential buy-to-let, commercial property is a business-to-business (B2B) market. Unlike property’s B2C market in which the relationship between landlord and tenant is largely one of landlord control, property’s B2B market is largely one of tenant control. Although landlords would regard themselves as being in the investment business, the big business is done by tenants whose businesses constitute the driving force for economic growth.
Unlike the B2C market where the tenant’s attitude toward the landlord and tenant relationship is easy to alight upon, the B2B market leaves landlords in the dark. The only clue as to whether a business tenant is doing well is that the rent and other payments to the landlord are on time, but since most tenants are honourable and would cough up regardless the facts remain hidden.
Amongst business tenants the desire for secrecy is not to keep the landlord at bay but to keep the competition guessing. Landlords get caught up in that only because the fewer people that need to know the truth the better. The need to keep up appearances is vital. For retailers, competition is intense. Not only between retailers competing on overlapping products and services but also customers adjusting their spending priorities. The retail workload is a struggle between maintaining profit margins and satisfying customers.
Unlike property which is fixed, customers are mobile. For the retailer torn between the commitment to a lease of fixed premises and the whereabouts of the majority of customers, the desire for customers is more important than keeping the landlord happy.
At rent review, the only reason a tenant would pay more is no choice. No retailer wants its profit margins reduced by the landlord’s desire for more rent, when any extra money could be better used to maintain and possibly grow the tenant’s business. The more the pressure of total property cost commitment (rent, business rates, insurance, service charge, etc) the more the likelihood the tenant will look for ways to escape.
With a long lease, the only ways for progressive retailers to escape are insolvency, assignment, sub-letting, and break clause. Deliberate insolvency (administration) annoys landlords the most so the tenant can lose out even with pre-pack. Assignment is not as popular with tenants since the outgoing tenant would probably have to enter into an AGA (authorised guarantee agreement). Sub-letting is preferable because the tenant retains control, but presents difficulties because modern leases mostly require any underlease to be outside LTA54.
That leaves the break clause. The period of notice to terminate is important As soon as notice is served, the final countdown begins. A retailer planning to quit will embark upon its preparation secretly; although with banks the intention to possibly close is consulted in advance – a list of possible closures can be found on-line – the vast majority of retailers remain quiet, often the first the landlord learns of the desire to break is on receipt of the break notice.
It costs a lot of capital expenditure and effort to set up shop and establish a going-concern. The only reason to want to leave is dissatisfaction and discontent, a feeling or knowledge the direction is wrong. When the landlord is imposing, often egged on by predators, when customers are overly-fussy or penniless, to relieve the stress, the retailer will want to leave.
Retailers talk about theatre and the customer experience, but a vast amount of time, effort, and money is wasted on ways to generate business, only to find that the people attracted are often the wrong sort of people. The right sort of people are paying customers, people whose spending-power and attitude makes the retail business worthwhile.
Successful investment in shop property and tenant direction go hand in hand with tenant paying customers. Any mismatch between the direction in which paying customers are going and the direction the business is taking will result in problems for the business. The landlord owns the property, not the tenant’s business. Landlords can suggest but retailers, being people, dislike being told what to do. For landlords whose leases contain tenant break clauses, keeping the tenant happy is likely to become harder to do.
The Rent Review Specialist