Britain’s leasing system has moved in tenants’ favour during the downturn. With stability returning, Mark Faithfull asks if the terms of retail property deals have now changed forever

It’s the classic duel: landlord versus retailer. In the red corner, the money-grabbing property owner, squeezing every last shekel from those poor, hard working engines of trade and commerce; in the blue corner, the ruthless, profit-laden traders, raking in customer cash but resentful of every morsel they hand over to their benevolent landlord. Their chosen weapon -the lease agreement.

Well it certainly can feel like that. UK leases have been the blunt instrument of power shifts, with traditionally the landlord holding the upper hand, but latterly the retailer. Yet, amid the sparring, an attempt to reach some sort of consensus has been pushed through, against a backdrop of shorter lease lengths, more flexible leases, variable payment terms and the CVA system.

Opening new doors

That need for a third way is reinforced by the fact that, while voids and secondary centre performance remain an issue, the UK retail scene is stabilising. Retailers may still hold the cards - in most locations at least - but the situation is no longer as cut and dried.

“Largely the tenant remains with the upper hand,” says Tim Hance, partner, in-town retailing, at agent King Sturge. “Supply is substantial and demand is pretty low and retailers are demanding terms on new lets not simply in line with what they are getting locally, but with the best they are getting nationally. Ultimately they can threaten to take a store to another town where they can get those terms.”

However, he distinguishes between super-prime and the rest. “In the West End and central London it’s as if there has been no recession,” he says. “Depth of demand - partly from foreign retailers, which perhaps have one chance to get a prime flagship location - has meant that retailers have had to sharpen their pencils for those sites.”

Elsewhere, the recession prompted most landlords to abandon the 25-year lease - which had typically already come down to 15 years - for 10 years, ideally with a break clause, or even down to five years. That brings the UK closer in line with mainland Europe.

“It had to happen,” says Ian Parish, head of retail at agent BNP Paribas. “With pressure from overseas retailers entering the UK market and British retailers outside the UK experiencing European leases, it was inevitable lease lengths would reduce. The downturn has simply accelerated the process.”

Parish adds that lease lengths are not the only area of compromise, with landlords including Prupim and Land Securities leading the way. “The approach of the big landlords is much more customer-focused and is continuing to move that way,” he says. “Landlords are becoming more flexible and that is here to stay.”

Attracting the right retailers

DIY retailer B&Q - a champion of lease reform - acknowledges that landlords are being more flexible and says some of its stores have moved to monthly payments, while at other locations it has negotiated new rental terms leveraging the strength of covenant it offers.

British Land senior asset manager Claire Barber says that the changes really began about two years ago. At Meadowhall that strategy has resulted in a fresh approach to asset management, with incentive packages, turnover rents and other shorter leases offered “for the right retailers”. However, she insists that with voids down at 1.9% and falling, rent-free periods are decreasing and turnover rents will only be considered where British Land is satisfied that it can establish a benchmark figure. “It has been used as an opportunity to freshen up the shopping centre,” she adds. “We’ve really looked to reposition the retail mix and we’ve strengthened footfall as a result.”

Moving with the times

Parish believes that flexibility will rub off, pointing out that retailers in the US sign shorter leases and often move around a mall, aligning their asset write-off period and shopfit to shorter tenures.

Lend Lease head of leasing Guy Thomas stresses this is already happening in the UK to some extent, citing Bluewater as an example where an area originally ‘anchored’ by a Habitat store and other homewares offers has more recently been colonised by US retailers Urban Outfitters, Hollister and Apple, plus Charles Tyrwhitt and Juicy Couture. Consequently, the whole dynamic of the area had changed and Lend Lease helped an existing retailer relocate to another part of the centre that it felt would be a better fit.

“A lot of our leases are outside the Landlord and Tenant Act so we have that flexibility to work with retailers,” he says. “We’re certainly not afraid to look at turnover rents or lease lengths. With a portfolio of 700 stores across the group we can benchmark performance and it makes it easier for us to assess a deal. The only thing I would say is that we need to move retailers away from one-size-fits-all. Turnover deals typically come in at about 8%, but different sectors work to different margins and the same approach does not always work.”

James Martin, director of Meadowhall managing agent Smith Young, says that moving retailers within a scheme has also been an integral part of the strategy since opening in 1990. “Next has moved three times, River Island twice, Gap twice, JD Sports three times and New Look three times,” he recalls. “That’s allowed them to upsize, downsize or move to a different area of the mall. Because our leases are outside of the Landlord and Tenant Act, we have been able to take an approach that is perhaps unusual in the UK.”

Both Thomas and Martin note that void rates are reducing while deal and transaction volumes have increased and that incentive schemes are now based predominantly on asset management. “We started leasing in 1990 on 35-year leases,” Martin recalls. “Now it will be 15 years, 10 years or even five years for the right retailer. But the deal has to work for us, rent-free periods have come down to between three and 12 months and we are in the fortunate position that not many of our retailers at a five-year break clause will want to walk away.”

Mark Painter, associate director, high street and London retail, of DTZ, adds: “Relationships inevitably become closer during hard times. But incentive deals have come down and tend to be no longer than 12 months now.

“The one change we will see further down the line is that a five-year lease negotiation is going to be very different from a five-year rent review. Things are changing.”

Indeed, group chief executive Simon Fox made clear at HMV Group’s results that lease expiries - 42% of its stores have leases with seven years or less to run - mean it will be pushing for the right deals for HMV Group. “It’s not our intention to come out of any stores,” he said. “We have a tiny number of unprofitable stores across the estate. We’re seeking rent reductions rather than store exits.”

DTZ head of retail asset management Peter Preddy adds that, for true co-operation, retailers’ disclosure of trading data still needs to develop. “The more open retailers can be the more landlords can help, although I appreciate it’s a very delicate issue,” he adds. “Ultimately, it’s all part of the jigsaw.”

Leases: The big five issues

Lease lengths

Our American and European friends are aghast when it comes to UK lease lengths, which traditionally have been far longer in the UK than elsewhere. With more overseas retailers entering the UK market and British retailers trying Europe out for size, it was inevitable that the duration of average leases would start to align with global practice and the downturn has simply accelerated that process. 10-year leases, with or without a five-year break clause, are still long compared with Europe and continued downward pressure is likely, although landlords will be reluctant to shift much further.

Flexibility

The very fact that leases used to run for 25 years tells you all you need to know about flexibility in legacy leases. But with shorter leases, incentive packages for incoming retailers and more hands-on asset management by shopping centre operators, the UK model is evolving towards the European/US norm. In the US, retailers expect to be moved around a mall and price shopfits and asset write downs accordingly. Shopping centre deals are now often outside the remit of the Landlord & Tenant Act, removing the traditional security of tenure at the end of a lease.

Turnover rents

Mostly a shopping centre issue, depending on the scheme, landlord and situation rents can now be fixed, base and turnover or turnover only. Turnover rents are tricky for institutional investors because they make income less certain. But landlords with larger portfolios have been able to benchmark performance levels to create turnover rents that provide a reasonable level of certainty. The outlet sector offers the most mature example, with all sales data fed back to the outlet manager and rentals purely based on turnover.

Monthly payments

At the height of the consumer downturn, retailers made a strong appeal to move to monthly rather than quarterly rents. Yet this issue seems to have fallen off the priority list. Major landlords Land Securities, Lend Lease and Standard Life have all confirmed that despite offering monthly rental payments at a number of theirshopping centres, retailer interest and take-up proved minimal.

CVAs

The buzz acronym of 2009 - a kind of UK version of Chapter 11 - CVAs were initially cautiously accepted as a means to prevent avoidable extinction (aka the sad demise of Woolworths). However, CVAs became a contentious flash point as landlords complained they had become an easy get out route and solvent retailers warned their struggling competitors were being handed an unwarranted advantage. The emergence from its CVA by DIY retailer Focus may prove a watershed moment in acceptance that CVAs can play a role in protecting businesses, employment and suppliers.

99p Stores: At your disposal

Value retailer 99p Stores has been a beneficiary of high void levels and retail collapses on the high street, opening its first in Holloway, London, in 2001 and aiming to reach 200 stores this year. Buying director Faisal Lalani says that the collapse of Woolworths and empty building rates legislation have given 99p Stores a double boost.

“The fact that landlords now have to pay rates on empty buildings has made many very keen to dispose of empty units and it can make a lot more sense for them to incentivise us to move in, because at least they lose that cost burden,” he says. “In addition, the demise of Woolworths meant a lot of retailers relocated from other parts of the high street to take their stores. I think we’re seeing the second wave of Woolworths, with retailers selling their leases on their vacated properties to other retailers.”

Lalani says that landlords have become more accommodating and co-operative, in part driven by the enhanced credibility of value retailing. “Discounters have become popular with landlords because they are footfall drivers,” he points out. “We see that especially with shopping centres, where a more institutional outlook means they take a longer-term view. On the high street, private landlords still tend to look for the best deal.”

99p Stores has also developed its offer with its new out-of-town Family Bargains format. Lalani says that marginal costs and turnover rents have made retail parks, strip malls and single units very attractive and he believes availability will remain strong.

“Because of the types of store and position we are looking for, we are not tied to a single town or location so we can afford to look around for the best deal,” he says. “To be honest, we’ve never had it so good.”