The legal framework that governs the relationship between landlords and tenants in the form of the Landlord and Tenant Act has created a long-standing confrontational dynamic.
It is a thoroughly antiquated model, and in behavioural terms is clearly unsuitable for the 21st century.
We live in a world in which owners and occupiers need to work together to ensure they can adapt to advances in technology and changing consumer behaviour. For this to work, owners and occupiers need to be sensitive to each other’s needs.
Leases have been shortening, a trend that is likely to be reinforced as companies are required to account for lease commitment as debt on the balance sheet (as determined by the International Financial Reporting Standard 16, effective from 1 January 2019).
Rather than relying on rigid contracts to maintain income, owners will have to create a product and offer a level of service that competes on merit. This can work to the owner’s advantage. Best-in-class owners will have the potential to differentiate by building cross-portfolio strategic partnerships with occupiers.
My company has seen this in practice within our Industrial Property Investment Fund, where we have worked with Travis Perkins to understand and support its strategic growth plans. This has culminated in L&G now being the largest owner of trade-counter premises in the UK.
Build-to-rent is also one of the best examples of a business built around short leases, in which the relationship between owner and occupier is vital. This scenario emphasises reputation; a poor reputation results in lower rents.
Conversely, a high level of service delivers improved returns to the owner through longer letting periods and reduced voids, as well as greater rents. Over the long term, competition will improve occupiers’ options, which will force a better level of service. Getting this right will ensure long-term returns.
Back in the world of commercial real estate, longer leases may at first appear more desirable to owners, but this depends on owners and occupiers working together over a long time in a collaborative way. For example, many business occupiers rely on fast connectivity.
If owners consider embedding well-specified technology and access into their offices at the outset, they can attract more high-quality tenants at higher rents who are then willing to agree longer leases. The initial cost for installation for the owner could be returned after five years of future rental income. In this instance, you would have both a happy occupier and owner, but this relies on a trusted relationship with a joined-up long-term vision.
The impact of the Minimum Energy Efficiency Standards on owners’ portfolios is another, more recent reason for owners and occupiers to collaborate. That is the only way to ensure that these sustainability targets are met.
At the moment, there is a discrepancy between owners and occupiers - often the occupier receives no benefits from having a greener building, and so is not motivated to care about lower running costs. Similarly, if the tenant is not vocal about their energy bills, the landlord seldom knows there is a problem.
Health and wellbeing is also emerging as a key area. Studies have shown that employers can achieve increased productivity from staff when they are operating in a healthy and well-designed environment. If such workplaces show enhanced employee retention, there is a strong incentive for owners to be more amenable on the relative pricing of assets that show these sorts of characteristics.
In the UK, there is an opportunity to reshape the landlord/tenant relationship into a new model; one in which the occupier is sensitised to the needs of the owner, and the owner understands and responds to the requirements of the occupier. This is where working together achieves more. Only then can real estate be truly productive.
Bill Hughes is head of LGIM Real Assets