By Viv Watts, co-founder of AGO Hotels
Long-term leases are a vital cornerstone of the commercial property market, and by extension the entire UK economy. The commercial property sector underpins our national pensions and insurance industries, supporting thousands of jobs and providing a safety net for millions of everyday savers and investors.
In the wake of the Covid-19 pandemic, the covenant strength of long-term leases looks to be profoundly weakened or in most cases, called into question. After all, we have witnessed large commercial tenants, including well-capitalised hotel groups and retailers with billions in cash reserves, opting to slash rent payments as their first line of defence for cash preservation. Take Whitbread’s Premier Inn, which unilaterally chose to cut rents by 50 per cent while holding almost £1bn in cash. Rent write-offs (as opposed to deferrals) directly seek to transfer value from property owners to tenants’ shareholders. There is no promise or mechanism for restoring that value to the landlords and their beneficiaries, including pensioners, insurance companies, charities, local authorities and so on.
All this highlights the fundamental imbalance in traditional leasing models – landlords have zero participation when markets are booming, but as soon as conditions become difficult for tenants, are the first port of call to prop up tenants’ businesses without having the same mechanisms of support.
This raw deal is at its clearest when viewed in light of corporate insolvency law. The law already provides numerous mechanisms for commercial tenants to strip out value for the benefit of their shareholders (often offshore institutions) at the expense of domestic savers and investors who prioritise stability and long-term income protection (think of your pension, benefits, healthcare and so on). Multiple successful businesses have been saddled with debt and had rents slashed as part of CVAs in thinly veiled attempts to extract value for offshore shareholders.
This trend is set to accelerate further, as new ‘cross class cram down’ changes to insolvency law make it even easier for successful business to be saddled with debt to maximise shareholder returns and effectively repatriate value for the benefit of offshore institutions, to the detriment of all other stakeholders.
In this context, asset owners in the hospitality and retail industries are looking for fairer lease structures, to share risks and benefits equitably between all parties. In the hotels sector, we are seeing a surging interest in hybrid lease models as an effective solution to achieve alignment between landlord and tenant interests. Landlords want to know that lease agreements are going to be honoured, which demands that leases are hardwired to achieve that, notwithstanding economic cycles (after all these are 15-35 year lease terms so future volatility is inevitable). This is why sustainable priority-paid Base Rent is the central feature of AGO Hotels’ hybrid lease, which has allowed AGO to pay rent in full and on time, even with our entire hotel portfolio closed over successive national lockdowns. Coupled with genuine profit participation, hybrid models give landlords the peace of mind of income security, with the offer of a fair share of profits when markets bounce back.
Although recent months have highlighted imbalances in current leasing models, they have also shown some leases to be more valuable than ever, namely when commercial tenants have honoured their obligations to landlords. However, what is fundamentally required is a wholesale re-evaluation of leasing structures, rather than relationships based on discretion. This is the only way to ensure a genuine and proportionate alignment between landlord and tenant interests. Any other approach will simply be window dressing.
