New leasing model potential winner for retail and leisure investors and occupiers

It’s been a week since English restaurants and many other leisure facilities re-opened for indoor service and over a month since shoppers were welcomed back into physical stores. While many are considering the short-term impacts of this, P-THREE has been taking a longer-term view in our Perspectives series on retail/leisure futures.

Occupiers may be less enamoured with the removal of the safety net offered by the 1954 L&T Act, but it’s really a case of swings and roundabouts: the shorter lease lengths offer them greater occupational flexibility. And the unpopular (with occupiers) upward-only rent review is removed from the equation

So far, we’ve covered supply and demand (the latter rising, the former falling) and rents (which dropped back as result of the pandemic, but have the potential to rebase through an increase in opportunistic lettings). For me though, the most critical part of the property equation, as I think it will determine how effectively retail, leisure and restaurant businesses will thrive long-term, is how new leases are structured. One thing is for sure: change is on the way. In fact, it is already happening.

The pandemic has pushed forward turnover rent agreements at a speed unparalleled in the previous two decades. They have been a great short-term fix, allowing both investors and occupiers to navigate a mutually-beneficial path through the difficulties of the last 12 months. And they are particularly popular with occupiers, as rents track actual store performance rather than a theoretical property rental model based on notional zonal demarcations. 

However, the past year has also highlighted the weaknesses of the turnover rent model: it isn’t sustainable (as brands wane over time) and (increasingly relevant in an omnichannel world) many landlords argue that it simply doesn’t reflect the true value of a bricks and mortar premises.

Interestingly, turnover rents have recently been accompanied by shorter lease lengths that have brought the UK more into line with the norm in continental Europe, and these have been welcomed by investors and occupiers alike. I think shorter leases, especially for retail space, are here to stay.

So, what next? I’m pretty sure that the traditional 10 year lease within the 1954 Landlord & Tenant Act won’t be making a strong post-pandemic comeback any time soon. If lease lengths move in and are agreed outside the Act investors will undoubtedly benefit (along with consumers) as they will be able to alter their tenant mix much more dynamically. Their exposure to CVA-related lease issues will also reduce correspondingly. The flip side of this, of course, is that investors will have to be much more pro-active: the days of sitting back and collecting the winnings from rental growth and yield compression are well and truly over.

Occupiers may be less enamoured with the removal of the safety net offered by the 1954 L&T Act, but it’s really a case of swings and roundabouts: the shorter lease lengths offer them greater occupational flexibility. And the unpopular (with occupiers) upward-only rent review is removed from the equation. Even so, occupiers will, quite reasonably, be less willing to sink capex into space they may only be inhabiting for a relatively short space of time. Accordingly, if investors are to remain on the ball, they will have think much more carefully about the level of fit-out of their buildings.

As we’ve pointed out the restaurant sector appears to be ahead of the game here with the most pro-active landlords semi fitting out units to attract the best tenants. There are signs that retail and leisure developments could follow: Areli Real Estate, for example, is considering just that at its Nicholson Quarter scheme in Maidenhead. Investors will benefit, too, as the quality of buildings (ie their assets) improves. To really exploit this, they will need take advantage of developing technology platforms to provide them with the requisite data.

Other leasing models (such as pay to enter and social media-related) are being floated and big names are still promoting turnover-related leases. However, I’m convinced that a new model, as described above, with either shorter lease lengths or slightly longer ones, which are subject to annual index-linked increases, and limited/no security of tenure – let’s call it SISO (Simple In Simple Out) – will appeal to enough occupiers and investors to become mainstream.

As well as offering them a fair deal, it could have the very welcome side effect of encouraging much more diversity in our high streets and shopping centres. In fact, SISO might just be the perfect antidote to Clone Britain.

Article by Hannah McNamara, Co-founder P-THREE

Photo credits: https://www.nicholsonquarter.co.uk