COVID-19 – Occupier dilapidations and business relocation reconsidered

Tom Callaghan, divisional director of AA Projects

Tenants have always had plenty to think about when approaching the end of a lease, even in the world that we lived in less than six months ago…

“How am I going to discharge my liabilities? Should I settle matters financially or undertake dilapidations works? What about negotiations for our relocation, or our strategy for fitting out secured new space?”

The worldwide COVID-19 pandemic, and the disruption to business we are all still navigating as a result of the virus, has added unprecedented levels of uncertainty and legal complexities that will further muddy the water. Many industry experts stand firm on their view that regardless of the economic factors, most occupiers will downsize by default in the wake of experiencing full-time remote working first-hand.

With this in mind, it has never been more critical for occupiers to base their real estate strategy and decision making on informed, commercially appraised advice. If you have a lease that expires within the next 6-18 months, you should seriously consider realigning your strategy, and quickly!

I’m yet to consider my potential liabilities under my lease. What should we account for?

IFRS 16 requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months. The time old tradition of applying a blanket £/sq. ft. rate over the extent of your demise is notoriously inaccurate, does not account for the intricacies of most leases and is increasingly not satisfying auditors.

I have already provisioned my dilapidations exit budget in accordance with IFRS 16 – is it still correct?

In short, not necessarily. Dilapidations liabilities arise from the costs associated with remedying disrepair, as well as undertaking reinstatement works in accordance with the lease and salient documentation. Determining the level of damages owed to the landlord is also driven by factors within the market at that time, as well as their future intentions for the building. Historic provisioning advice may have been based on a market rife for significant refurbishment or redevelopment, such as Central London offices, however there is the potential that this pandemic will significantly delay such plans.

This specific example is likely to mean that the principles of Section 18 is going to have less impact on a potential claim, and therefore the occupier should provision much more robustly. The world of today is very different from that of a number of months ago, and as such even a high-level review of your dilapidations liabilities makes sense whilst you have time to act.

My lease is due to expire in six months and I’m yet to engage with my landlord.  What should I do?

Given the current uncertainty, our advice is to open lines of communication as soon as possible. It is fair to assume that the majority of landlord’s will continue to pursue claims in accordance with your lease terms, regardless of any impact upon your revenue as a result of COVID-19, so engaging in conversations early is imperative in order to plan for exiting with minimal financial impact on your business.

There is a possibility that some institutional landlord’s may choose to relax their processes from a reputational perspective, as they have with rent collection, however we consider that this may only happen in the event of a second wave.

Either way, AA Projects are able to commence or pick up conversations with your landlord to explore the various options for dealing with dilapidations negotiations.

Our relocation negotiations are ongoing but have been delayed by the pandemic. This transaction now represents a potentially heightened risk to our business – are we still best advised to proceed?

Each and every situation will be different. A due diligence survey is always recommended prior to entering into a new property lease considering factors such as service charge implications, wider building fabric/plant condition, legal drafting and demise limitations. In times of uncertainty, this review can also serve the strengthen your negotiating position, driving improved terms, as well as highlighting risk which can hopefully then be mitigated. Decreased demand for space is likely to result in an occupier led market, so why not benefit from being in a fully informed position?

Proactive advice is imperative to business continuity

Ultimately, dilapidations and technical due diligence matters require a level of expertise that can only be provided by specialists within the field.  These skillsets are often an afterthought to many occupiers, however, the wider macro-economic situation has placed extraordinary financial pressures upon all involved parties. Our experts pride themselves on providing proactive solutions, allowing you to concentrate on your core business in times of uncertainty.

Whilst the above examples are perhaps the most straightforward scenarios that our occupier clients are likely to find themselves in currently, there are a whole host of others that could arise:

  • Break clause conditionality
  • Contractor delays on your dilapidations project
  • Relocation programme issues
  • Fit-out contractor procurement to progress design