Capital & Counties has long enjoyed an enviably strong hand in rent negotiations.
As the owner of London’s Covent Garden market, a magnet for millions of foreign and domestic tourists who can shop and dine along streets dating back to the 17th century, the property company is not accustomed to offering concessions to tenants ranging from multinationals like Apple to independent businesses.
But the coronavirus crisis has ripped up that script. With foreign tourists staying at home and the UK economy in recession, the London-listed company is for the remainder of the year offering some tenants variable leases, where the level of rent is tied to how much turnover a business generates.
There are few starker illustrations of how the pandemic is forcing property companies dependent on the retail and hospitality industries to think what might have once seemed unthinkable. Across the world, the pandemic has unleashed a high-stakes debate over whether rents should be fixed or linked to some measure of how a tenant’s business is performing.
As rising infections in the US threaten more crippling lockdowns, fashion chain Urban Outfitters is among a growing number of retailers calling for variable leases to help them weather the pandemic. In France, the government tried and failed to mediate a bitter argument between retailers and landlords, many of whom are resisting attempts to rewrite previously sacrosanct lease agreements.
Chip Bergh, chief executive of US fashion chain Levi Strauss, is clear: “A fixed lease, especially at pre-Covid levels, could become economically punishing.”
“There could be an extended period of time where you have to limit the number of people coming into your doors,” he adds, noting that as well as lower sales, retailers also face higher costs due to cleaning and other safety measures. “That puts a financial burden on us and we’re just looking for landlords to share in that pain.”
Rémy Baume, chief executive of Zadig & Voltaire, the French clothes retailer, agrees.
“During the recovery period, we need variable rents and not fixed ones,” said Mr Baume. “This would align both sides’ interests as we come out of the crisis.”
For some property companies, the scale of the calamity that has engulfed their tenants means rewriting lease agreements and sharing the pain is necessary.
US cinema chain AMC Entertainment, Canada’s Cineplex and global fashion retailer AllSaints are among companies that have made progress towards agreements that link rents to the level of turnover.
Scores of US businesses, including Tommy Hilfiger-owner PVH and The Cheesecake Factory, have sought relief on rents. In many cases, landlords have conceded irrespective of the wording of leases, given the near impossibility of finding alternative tenants.
“It’s definitely happening a lot more,” Vince Tibone, retail sector head at Green Street, the commercial property research firm, said of variable leases in the US. For many landlords, he said, “it’s the least bad option”.
Even if some UK retailers have reported encouraging sales since the lockdown began to be eased in May, no one disputes the sector remains in the grip of a crisis. Intu, the country’s largest shopping centre owner, collapsed into administration last month.
Although the gravity of the situation has prompted some landlords to conclude that having less rent is preferable to a bankrupt tenant, the fight over leases has sometimes turned ugly.
In April, a group of about 30 French retailers and trade associations wrote an open letter in the Les Echos newspaper urging landlords to tie rents to revenue for the rest of the year. With major French landlords such as Unibail and Klépierre refusing such demands, the French government attempted to mediate, but that process failed last month after retail trade associations rejected a proposed compromise.
Bris Rocher, whose family-backed company owns French beauty products company Yves Rocher and kids clothing brand Petit Bateau, has been a vocal advocate for renegotiating leases.
“Decent” trading at the company’s 800 or so stores since they reopened in mid-May had softened the blow, he said, but the company decided to close a shop on Boulevard Haussmann in Paris. Fewer tourists, particularly from China, meant “we were losing money on the store. We tried to go to a variable rent but the landlord was having none of it,” said Mr Rocher.
Whether in the US, the UK or France, retailers have so far only pushed for variable leases, which can also include a fixed one-off payment, until the end of the year. But with the pandemic turbocharging the migration of consumers from physical stores to the internet, some sense both the chance and need for a more permanent change in leases.
“In the UK, there has been a huge acceptance among owners and occupiers that our way of occupying commercial space is broken and there needs to be radical change,” said Mark Robinson, chair of the High Streets Task Force, a government-appointed body of experts which advises on supporting and transforming local high streets.
A survey of UK landlords by property consultancy Colliers in May found that 40 per cent would now be more likely to factor turnover, footfall or online sales into lease agreements.
Brian Bickell, chief executive of Shaftesbury, a UK-listed property company whose portfolio includes London’s Chinatown, acknowledges that the industry may be at an era-defining juncture.
“I think landlords now are going to have to accept more risk sharing in terms of taking on turnover rents,” said Mr Bickell, who has offered turnover-linked leases to restaurants and cafés. “At the end of the day it’s got to be affordable for the tenant as well.”
However, a concerted effort to make turnover-linked leases more mainstream would bring its own tensions as well as potentially radical ramifications for property companies.
For restaurants, cafés and bars, such leases would be relatively straightforward because sales take place on site. But a thorny challenge for retail landlords is establishing how much of a tenant’s revenue is attributable to a physical store.
“I don’t think anyone’s cracked how you capture online sales [when setting variable leases],” said Mr Bickell. “The brand value of having a bricks-and-mortar store in [London’s] Soho is huge, but how do you ever know which shop is driving turnover?”
Hammerson, a UK and European shopping centre owner hit hard by the pandemic, argues that any move to link store rents to the level of turnover must include online sales, too. But that would require tenants providing a level of detailed information to landlords that they have historically been reluctant to do.
“If we had a property market where we hadn’t had 50 years of mistrust between tenants and landlords it might be OK,” said Dominic Curran, property policy adviser at the British Retail Consortium. “But tenants think landlords will use it as a stick to beat them with, to drive up rents.”
If turnover-linked leases were ultimately brought in from the industry’s periphery, investors say it would also change the perception of a sector where company valuations have typically been underpinned by stable income streams and the allure of dividends.
“Investing in commercial property, you’re investing for income,” said Tim Munn, chief investment officer at Mayfair Capital, the UK arm of asset manager Swiss Life. “Accepting that rental income can go down as well as up brings more risk for risk-averse investors.”
Mr Munn and other dividend-hungry investors have no need for panic. Variable-linked leases still account for a small share of retail landlords’ income. Simon Property Group, the largest US shopping mall owner, generated $4.9bn from fixed leases last year, more than five times that it made from variable ones.
But if a significant number of consumers fail to return to shops and restaurants in the coming months, the pressure to permanently rewire lease agreements will only grow.