How will retail fare post-Covid?

Property Week editor Liz Hamson joined Rob Thompson, partner and head of real estate sector, UKIME, at Dentons, to discuss what needs to change to fix the relationship between landlord and tenant.

RT: The impact of Covid-19 and the lockdown measures over the past 12 months has been profound, not only for retailers and those operating in the hospitality sector but also for landlords. Many predict a surge in consumer demand in both the retail and hospitality sectors as we come out of lockdown. But many landlords will be licking their wounds for some time afterwards due to concessions offered to tenants. These range from shorter leases being taken, rent reductions, rent-free periods, rent deferrals, monthly rent payments or switches to a turnover-based rent model.

In some instances, we have seen tenants willing to agree lease term extensions as compensation to soften the blow for landlords and we have also seen arrears written off. We have also seen some high-profile CVAs, including the likes of Travelodge. Many see these as a cynical exploitation of the insolvency regime by investors in order to recapitalise their businesses at the expense of their landlords.

LH: Do you think the relationship between landlords and tenants will continue deteriorating, or are there small signs of improvement? Are retailers starting to be more realistic about their expectations?

RT: I think they are being a bit more realistic. In a sense, the irony of the Covid-19 situation has forced minds to focus on both sides. In many cases, landlords and tenants have been driven together by the economic impact of the pandemic, but it remains to be seen what will happen after the government protections such as the evictions moratorium are taken away.

LH: Do retailers still have the upper hand?

RT: Very much so, yes. I think that will likely be the case for some time and it will be interesting to see what happens in relation to this period. Going forward, those retailers that have engaged with their landlords – that have sought to agree re-gearing the terms of their leases – will be in a good place coming out of the moratorium; but, of course, for those that have buried their head in the sand, perhaps less so.

LH: There has been a lot of talk about the greater need for flexibility, such as a switch to turnover-based rents and shorter lease lengths, and ultimately for more of a partnership approach between landlords and tenants. What needs to change to make that happen?

RT: There are a lot of good examples where turnover leases work but, overall, they only represent about 10% of the rent arrangements across the sector. Landlords have been reluctant to abandon the traditional model of fixed rents, and many have been unwilling to really get under the skin of how tenants are operating their businesses.

The spate of retail failures has made landlords sit up and take notice though, and I do think more flexible lease terms are here to stay. But I do not think we are going to see a wholesale switch to turnover-based leases in the short term. Instead, we might see more leases with fixed base rents and certain turnover-based top-ups, which will give greater security for landlords when they come to do their valuations.

LH: Will that 10% rise?

RT: In the next three to five years, I think we will see that rise to something like 25% or perhaps north of that. A key element of this is whether lenders can get comfortable with things in terms of valuation methodology.

LH: What sort of lease length will become the new normal?

RT: The day of the long institutional lease had probably had its day, although it will vary from property to property. But you will see those lease terms come down to perhaps five years, or less in some locations.

LH: What impact has the moratorium on evictions had on landlords?

RT: It has led to a very one-sided playing field, with tenants very much having the upper hand. It has led to many retailers considering the moratorium as almost a free pass to not pay rent, and some of those businesses have arguably got stronger during the course of the pandemic. What is not spoken about so often is the impact this has had on the pension funds and the individual investors that underpin those, and the adverse impact that has had on those investments; lenders too have been affected.

LH: What will be the impact if the moratorium is extended?

RT: Rent liabilities will continue to roll up, and it will just be kicking the can further down the road if measures are extended. Now that we have an indication of when lockdown measures will be eased over the coming months, hopefully we will return to some semblance of normality.

LH: What do you think will happen to the relationship between landlords and tenants further down the line, post-pandemic?

RT: There are a lot of structural issues within the retail sector that have been prevalent for some time. In many cases, landlords will not benefit from taking premises back because re-letting them will be very difficult. In one sense, landlords will I think be forced to take a pragmatic approach.

LH: Do investors see retail as a bargain basement opportunity?

RT: Some parts of the retail sector continue to look resilient, including the supermarket sector, which continues to attract interest, especially for long-income investors. The convenience retail market has seen a lot of activity as well. More broadly, I think many retail investors are wary of committing capital to the sector as they will want to see if consumer behaviour is likely to change post-lockdown.

LH: What do you make of the mixed-use future for the likes of Oxford Street?

RT: The perception of how Oxford Street should look is changing quite significantly – for example, the way department stores are used. There is an opportunity to repurpose those and combine retail with food and beverage and, no doubt, offices and residential.

LH: What cities can London look to for inspiration?

RT: You look at places like Amsterdam, where there is a lot of smaller retail that sits around clusters of residential accommodation. It is a smaller city of course, but you can see how town centres and cities can be created to have much more of a village feel.

LH: What will be the immediate challenges in moving towards a more mixed-use future?

RT: It is going to be very capital-intensive and there is going to be a lot of private capital required. I also think the planning system needs to be a bit more dynamic and responsive in terms of how some of these urban centres and retail outlets will need to operate in the future.

LH: What would you like to see introduced on the tax front that could unlock some of this transformation?

RT: Although we have got current relief measures in front of us, they are not sustainable.

I think we need to look very hard at business rates and perhaps more regular and targeted reviews of rateable values. I expect the government will also look closely at an online sales tax to ensure the retail playing field is levelled between physical in shop sales and online sales.