Managing Bricks & Mortar

The British high street's state of flux continues. Even prior to the pandemic rollercoaster, claims of the 'death of the high street' persisted. But examples to the contrary crop up with increasing frequency as retailers adapt the physical space to help drive consumer traffic. Finding new ways to extract value from existing physical portfolios will be high on retail leaders' agendas in 2022. 

Retailers are increasingly marrying the physical in store aspects of bricks and mortar with the best features of digital e-commerce and social marketing to create a unique and integrated shopping experience. Successful adopters of phygital have demonstrated a commitment to product storytelling, consumer loyalty and fierce collaboration with social media platforms / tech giants.

The impact of Covid has had a social and economic impact on commercial property and raises very obvious questions about the need for space going forward. With the trend for flexible working and online retail likely to continue it seems likely that many sectors will see a real change to the requirement for physical space in the post-pandemic world, both in terms of the volume of space required and the specification of that space.

Occupiers should look carefully at the the terms of existing leases and should check, in particular for opportunities to break those leases where the space is not required going forward. Exercising lease breaks can be very complex, particularly where there are conditions attached to the right to break. Any such conditions need to be strictly complied with. 

Landlords too need to be aware of the prospect of tenants exercising breaks and, in some cases, may be able to avoid this by talking to tenants in advance of break dates about whether a compromise position could be agreed. This may involve less space and more flexibility for the tenants in return for a further period of guaranteed income for the landlord.

If there are no break options, then parties may wish to consider lease renewals and tactics for timing and valuation. New terms may also include Covid and similar disease wording clauses. Over time a body of comparable evidence will emerge which will assist the parties in assessing the impact on a particular property. For landlords, there is an opportunity to consider redevelopment of property in order to strike deals with tenants to reduce space to allow this. 

To accommodate the evolution of the high street and the impact of Covid-19, landlords and tenants are reviewing the traditional structures of their leases and examining the viability of certain trends.

Turnover leases: Covid-19 has seen a big push by tenants for turnover based rents in their leases, seen as a way of sharing risk with the landlord of reduced footfall and outright store closures. Indeed, the market is seeing some institutions actively embrace the turnover rent model (such as L&G’s "flexible partnerships model" of different types of turnover lease). The usual challenges remain however – removing certainty of income by going to a complete turnover rent model is particularly difficult for landlords to accept, but even if that hurdle can be overcome, the negotiation of what is included in the turnover calculation is far from straightforward. Covid-19 has of course driven more activity online and that brings this point into even sharper focus - how do we allocate online revenue in terms of an individual store’s turnover? Some have suggested that it be apportioned to stores based on sales within a certain distance of the store, but that seems quite arbitrary (and potentially very difficult to monitor). The debate will continue, but it will also be interesting to see the extent to which leases do move to a turnover rent model. Despite much discussion of this, a recent survey by Savills found that retail landlords are not expecting a significant move to turnover rents this year (with respondents saying that they expect only 7% of leases to move to a turnover based rent in this year). Whether this is more hope than expectation on the landlords’ part remains to be seen. 

Other changes: Unsurprisingly, the market is seeing a push by tenants for shorter terms or a wider ability to end leases early. Again, a balance will need to be found between this and the longevity of income needed by landlords for their investment to stack up. As the drive towards contributing to a sustainable future increases, more and more retail tenants are also requesting the incorporation of "green lease provisions", to incorporate specific obligations and/or flexibility to deal with issues of sustainability, energy efficiency, waste management etc.

The Government's Code of Practice for Commercial Property Relationships during the pandemic encouraged a collaborative approach between landlords and tenants to navigate the impact of the pandemic on the commercial property sector. It advocates principles of transparency, acting reasonably and responsibly and adopting a unified approach. At its core is a message of striking a balance and sharing risk. Landlords and tenants alike are alive to the fact that normal service may not be resumed, in the short term or possibly at all. New ways of collaborating for the benefit of both parties will need to be pursued in order to protect the long term interests of both landlords and tenants.

One of the key lessons of the pandemic has been to reiterate the importance to retailers of a strong logistics network. That’s reflected in the real estate market too - logistics investment has increased markedly during 2021, in some regions accounting for up to a third of overall activity. This feels like an area of bricks and mortar where we will continue to see investment by both tenants and landlords for some time.