Investors should remember that the value of an investment and the income received from it can go down as well as up, and that they may not get back the amount they invested. Sage advice for any investor.

You may think it odd then that commercial office leases in the UK still provide for the annual rent agreed at lease commencement to be subject to rent review on an ‘upward only’ basis.

Rent reviews became common in commercial property leases during the 1960s and 1970s as a mechanism for adjusting existing lease rents to current market levels. They were devised specifically to protect the value of landlords’ interests in an inflationary environment whilst enabling tenants to secure traditionally favoured long-term leases.

In the UK rent reviews typically occur once every five years and it is now unusual to come across office leases that provide for a longer review pattern. Upward only means that the rent paid by the tenant cannot reduce at review time, even if the open market rent at the relevant review date is deemed to be lower than the rent passing.

Whilst it is too early to forecast how the market will fare post the immediate crisis, all of the tenant representatives and brokers we have spoken with intuitively feel that rents will come under downward pressure. Only time will tell!

The British Property Federation (BPF), the trade association for UK landlords, noted that the traditional upward-only rent review remains dominant in the UK commercial property market and, indeed, is seen by some as a major contributor to the attractiveness of the UK market to commercial real estate investors. Consequently, there is little appetite to change the ‘status-quo’, but occupiers are likely to think differently if exposed in a falling market to over-rented premises which prove both expensive and difficult to dispose of.

Intended to improve transparency and fairness in the negotiation of commercial leases, the new RICS ‘Code for leasing business premises’ (1st edition, February 2020) was an opportunity missed to pivot away from the constraints of upward only rent reviews.

With businesses haemorrhaging cash and searching for ways to stem the bleeding, occupiers across the retail, leisure and F&B sectors are actively seeking relief through rental waivers and deferred payments. Certain flexible space market (FSM) providers are closing down centres and seeking CVA arrangements to protect and survive. And, as various well-known retail brands enter administration, the case for business rates relief to enable the high street to compete with online retail grows ever stronger.

The shortening of leases over the past two decades has represented a major structural shift in the commercial property market. Rarely these days will occupiers sign-up for 25-year leases unless they are entering into very large lettings (and pre-lettings) or acquiring premises requiring a high level of fitting-out capex.

The average office lease length in the UK today is now closer to 5-years, having come in from the average lease length of 6.8 years in 2014. The impact of IFRS 16 requiring tenants to bring all operating leases on balance sheet (by recognising a ‘right-of-use’ asset and corresponding lease liability) may have also influenced some occupiers’ decisions to enter into shorter lease terms post January 2019.

As businesses review their space and headcount requirements, the risk for owners and investors is that faced with an upward only rent review and a significant deficit between the rent paid and market value, tenants will vote with their feet, exercising lease breaks which may be coincidental with the rent review. In extremis, they could even default, leaving landlords with unwanted vacancies and possibly also significant rent arrears. Consequently, on new lease acquisitions it is to be expected that occupiers will gravitate towards those properties which offer more flexible lease terms, including enterprise spaces within the FSM sector, given the likely trade-off between pricing and lease flexibility.

With landlords facing billions of pounds in lost or deferred rents and expected to take another hit at the June rent quarter-day, there clearly needs to be a recognition of the problems faced by both owners and occupiers. It will be interesting to see whether the Covid-19 pandemic acts as a catalyst for change.

Since there has been little debate on the merits of incorporating upward and downward rent reviews in new lease agreements (maybe there are too many players with vested interests?) we asked our friends, Paul McDowell and Stuart Allison, to explain how rent reviews in Ireland and Australia work. Here’s what they had to say…

Paul R McDowell, Principal, Paul McDowell Ltd, Dublin:

“Up until January 2010, Ireland followed the UK practice of upward only reviews. However, these were banned by law following tenant lobbying pressure as a consequence of the 2008/9 economic crash. In reality, it has had little effect as rents in all sectors continued to increase following the historic lows of 2010. Some landlords now favour indexed rents at review with caps & collars. Obviously, future rent reviews will be more impacted as rents are destined to fall due to the current pandemic.

In terms of investment, it did create a marginal two-tier market between assets with pre or post January 2010 leases, but a move towards a pattern of shorter lease terms and 5-year breaks largely negated this difference. One now needs to make a more critical assessment of rental values when arriving at capital value decisions. However, such market reviews have had zero negative impact upon the large swathes of overseas investment flooding into the Irish market since 2010.”

Stuart Allison, CEO & Principal, ResolveXO, Melbourne & Sydney:

“Market rent reviews are becoming a less common feature in Australian commercial property leases with most landlords and tenants preferring to agree to annual increases across the term of the lease for certainty, typically 3% to 4% pa.

Rent reviews usually only occur in leases at the commencement of an option to extend the lease period but even then, both parties typically prefer to work out the terms of any renewal package in advance, with landlords preferring higher face rents, and tenants preferring to negotiate and receive more generous incentives.

This is a change on 20 years ago where upwards only (known as ratchet clauses locally) face rent reviews were commonplace. While rental growth has been consistent since, incentive packages have been on a roller coaster and this has driven both parties to work towards a process that allows for a closer outcome to market. We are even seeing clauses now that require the determining valuer to provide a determination on the rent and market incentive!”

We are keen to hear your views on any issues affecting corporate occupiers, and how businesses might adapt and evolve in the new normal. Please e-mail us with your thoughts.

 

When life returns to normal after Covid-19 has abated, the big question for many businesses will be “what does normal look like?” After analysing their business’s response to social distancing measures, for some corporates there is likely to be a realisation that they are renting more office space than they actually need. GoSpace AI Chief Partnership Officer Neil Usher notes that every company that has conducted a space utilisation study has consistently found that between 25-50% of desks are unused throughout a day.

Factor in the impact of the Minimum Energy Efficiency Standard (MEES) Regulations on older inefficient office properties, and we arrive at a scenario where occupiers are exiting sub-standard office stock and concentrating core business activities in the best and most efficient real estate. With a breaking down of perceived cultural resistance to remote working perhaps the next big question to ask is ‘where should those core activities be located?’

We are keen to hear your views on how businesses might adapt to the new normal. Please email us with your thoughts.

Thank you and, please be more careful than you think you should.

McCalmont-Woods Real Estate, the specialist London based Tenant Representation real estate agency, is proud to have advised Neptune Energy on relocation to its new London office at Land Securities and Canada Pension Plan Investment Board’s Nova development in Victoria, SW1.

Neptune is an independent international E&P company and, having completed the acquisition of the exploration and production business of the ENGIE group in February 2018, is now active across the North Sea, North Africa and Asia Pacific. The Company is backed by funds advised by three investors, China Investment Corporation, The Carlyle Group and CVC Capital Partners.

Neptune has taken 11,000 sq ft offices at Nova North bringing the total office floorspace acquired and let by MWRE for energy sector clients in London to date to over 130,000 sq ft.

Newsquest Media Group Limited advised by tenant representation specialists McCalmont-Woods Real Estate LLP has taken a new lease on Queen’s House, 28 Kingsway and 55-56 Lincoln’s Inn Fields, WC2 in London’s Midtown district from Capel House Property Trust Limited advised by Gale Priggen & Co.

Newsquest has signed a new lease on the 3,700 sq ft part 4th floor in Queen’s House, an impressive period property situated on the west side of London’s largest public square. Initially planned in 1913, development was put on hold in 1914 due to the outbreak of the First World War and the building was only subsequently completed in the early 1920s since when it has remained in the ownership of landlord Capel House ever since.

Lincoln’s Inn Fields, originally laid out in the 1630s with a brief interruption for the English Civil War (1642-1651), has long had an association with the legal sector and over the years has been home to numerous solicitor’s firms and barristers’ chambers. In Charles Dickens’ novel Bleak House, the sinister solicitor to the aristocracy, Mr Tulkinghorn, has his offices in Lincoln’s Inn Fields!

Today the Square is home to some of London’s most noteworthy organisations including the London School of Economics and Political Science who also occupy space in Queen’s House and next door in a £71 million state-of-the-art building at 50 Lincoln’s Inn Fields. Other notable occupiers in the Square include international public relations company Brunswick Group; the Royal College of Surgeons and the Centre for Commercial Law Studies – part of Queen Mary, University of London. The Sir John Soane’s Museum, which attracts over 100,000 visitors a year, occupies no. 13 Lincoln’s Inn Fields, the house being left untouched since the distinguished architect’s death almost 180 years ago.

Earlier, in June of this year, McCalmont-Woods advised Newsquest’s Specialist Media arm on its relocation from 30 Cannon Street, EC4 to 6,000 sq ft ‘creative style’ offices at 120 Leman Street, E1 in the heart of London’s vibrant Aldgate quarter on the east side of the City. Newsquest Specialist Media, who publish both commercial and B2B titles such as Insurance Times, Strategic Risk and Global Reinsurance amongst other brands, signed a new lease on the refurbished offices with landlord Grainmarket advised by Hall Kemp.

Lisa Isaac, Group Purchasing Manager at Newsquest said “Having met with several potential advisers, the team at McCalmont-Woods impressed us with the way they focused on our needs and brief, finding the property to fit as opposed to starting with available properties and trying to shoehorn the brief to match. We had some tough ‘asks’ and we certainly put Nick’s extensive experience and market knowledge to the test. The Specialist Media team were very pleased with the move to Leman Street and we had no hesitation in appointing McCalmont-Woods to help find our second property in Midtown; a second successful project despite the incredibly tight deadlines. Knowledgeable, jargon-free, helpful and focused, I look forward to working with McCalmont-Woods on future projects.”

Newsquest is the UK’s second largest publisher of regional and local news with a portfolio of more than 165 news brands and over 40 magazines, published in print and online. With an audience of almost 30 million users a month online and 6 million readers a week in print, Newsquest’s content is read by a substantial proportion of the UK population. Newsquest employs over 1,000 experienced media sales people that help local businesses promote their products and services to local audiences. Newsquest is owned by Gannett Co., Inc. the largest news publisher in the United States whose assets include USA Today and USA Weekend. Gannett is listed on the New York Stock Exchange with the symbol “GCI”.

Faced with the imminent expiry of its office lease in 33 Grosvenor Place, Belgravia, Hartree Partners (UK) Limited turned to tenant representation specialists McCalmont-Woods Real Estate LLP for help in finding a new London office space.

Working to a tight timetable and with Victoria offices in scarce supply, McCalmont-Woods successfully identified and negotiated a new lease on 11,300 sq ft Grade A space at Cardinal Place, 100 Victoria Street, SW1 with landlord, Land Securities.

Formerly occupied by Microsoft, the 2nd floor offices needed refurbishment and in recognition of the tight timescales involved, it was agreed that office design & build specialists’ Peldon Rose would undertake both the landlord’s Cat A works and Hartee’s own Cat B fitting-out works in order to accelerate Hartree’s move-in date.

Land Securities’ 660,000 sq ft Cardinal Place is undoubtedly one of the most recognisable sights in Victoria, the dramatic sweep of its glass facade narrowing to a single point at the corner of Bressenden Place and Victoria Street. A new entrance to the underground and north ticket hall (providing improved access between the National Rail and Tube platforms) is due to open shortly immediately opposite the entrance to Cardinal Place.

Jon O’Neill, Hartee’s Managing Director said “Nick did a great job of finding a new London office space for Hartree. We appointed him after a previous property deal fell through at a late stage, leaving us with a relatively tight timeline to find new office space. Nick worked hard and found us a great space before it got advertised on the open market. He is a good communicator and we felt very well informed throughout the whole process; we would not hesitate to use him again”.

Hartree Partners, LP is a global merchant commodities firm specializing in energy and its associated industries. Founded originally as Hess Energy Trading Company LLC (HETCO) in 1997, Hartree has a global reach spanning 10 offices and approximately 85 traders and originators. The company’s rigorous research, analytical approach, and entrepreneurial culture have contributed to its strong track record and growth over that time.