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Flexible lease options for UK real estate

commercial-building Print publication

04/08/2021

In uncertain times, flexibility is key. The need for businesses to react and adapt to post-pandemic, post-Brexit markets is driving increasing demand for flexible occupation arrangements, particularly in the office, retail and hospitality sectors.  Walker Morris’ Mark Byrne and David Manda, specialists in commercial landlord and tenant-focused transactional real estate work and real estate litigation respectively, offer a practical overview of flexible lease options for UK real estate owners and occupiers in the post-Covid climate.

Commercial context

Political and economic change in recent years, and more recently the effects of the pandemic in 2020-21, have simultaneously created uncertainty and opportunity – the latter largely through technology and digital innovation across all sectors. With perhaps the exception of large warehousing, industrial and logistics developments, these market forces have created increased demand within UK real estate for flexibility in leasing and occupation arrangements.

What are the options?

In the vast majority of existing commercial leases currently in effect today, the traditional options of exercising lease breaks and/or assigning or sub-letting premises will be available to tenants who wish, for whatever reason, to rationalise their property portfolio, to depart premises altogether, and/or to re-negotiate their terms of occupation.  However, such options are always constrained – both by the terms of the existing lease and any head lease[s], and by the buoyancy (or otherwise) of the market.

So, are there more flexible options available to landlords and tenants who are considering or negotiating new arrangements?

In terms of office occupation, ‘flexible’ or ‘serviced’ office arrangements are rented work spaces that are fully serviced and maintained by an operator. They can vary in size from a single desk to an entire floor, depending on the occupant’s needs which may change over time. The take-up for flexible offices had already begun to increase prior to the pandemic, but the results of a ‘Re-occupancy & Re-imagined Workspace’ survey carried out by Knight Frank in 2020 found that, post-Covid, 47% of UK businesses (including large, established businesses), envisioned incorporating flexible office space into their real estate strategies.

At first glance, it’s not difficult to see why this form of occupancy has become so popular. Agreements can be made, and occupation can commence, quickly and easily. Arrangements are typically made via a licence for any duration that suits the occupant. This creates a flexible and practical arrangement, ideal for coping with an ever-changing market, and providing room for businesses to grow and develop how and where they wish.

However, the flexible office space model can have implications that are legally problematic and that can even compromise businesses’ commercial interests. For example, it is what actually happens ‘on the ground’ which determines the legal nature of an occupancy arrangement, not necessarily what is written into any express agreement.  The informal and ‘ad hoc’ sharing of office space between different businesses can lead to a legal minefield, often resulting either in parties having less security than they had required, or being more tightly bound to property commitments than they had intended.  It can also raise issues with client confidentiality, security of data, software, physical files and even the safety, security and well-being of staff.  For specific legal and practical advice in relation to flexible office arrangements, see our more detailed briefing.

In terms of retail and hospitality, landlords, tenants, the UK Government [1] and local government regeneration projects are all becoming increasingly aware that, for high streets to survive and thrive, creativity, collaboration and dynamism will be required when it comes to occupation arrangements.

Changing customer behaviour and a cultural shift towards more local, independent, socially-responsible consumerism mean that gaps created by large scale retail and hospitality departures [2] are likely to be filled going forward, to a significant extent, by small, non-chain, start-up, artisan, businesses [3].  Town and city centres will therefore need to need to be welcoming to such businesses and their customers, and capable of adapting to their differing and ever-changing needs.  Traditional long-term commercial leasing is unlikely to be feasible or favourable to any party in these circumstances.

Alongside shorter lease terms, more frequent break options, pandemic clauses and flexibility in payment of rent provisions (all of which can benefit both parties because they allow flexibility and manoeuvrability for tenants, and facilitate more frequent rent reviews and more likelihood of a reliable income for landlords), the high street is already starting to benefit from an increase in turnover rents, wider permitted user provisions and a more co-operative, symbiotic approach to commercial property occupation.

For example, in July 2020 institutional investor landlord Legal & General launched a new commercial leasing framework (which L&G have referred to as a ‘flexible partnership model’) which offers a menu of different length contracts; different levels of complexity, security and commitment; and different rent calculation and review provisions for different types of business.  The idea is to create almost a tailor-made arrangement to support businesses and to collaboratively share risk and reward between landlord and tenant.  Ultimately it is expected that that will generate increased and better quality occupier activity for L&G and enhanced cash flow for occupiers.  Similarly, Hammerson announced in August 2020 that it would offer lower rents, shorter leases and creative turnover rent provisions which must be based on transparency and trust between landlord and tenant.

What practical advice arises?

In the same way that Covid-19 prompted unprecedented change in the way people live, work, shop and socialise, and in the same way that it urgently facilitated huge advances in technical and digital communication and capability, so too is it likely to revolutionise commercial real estate options in the UK.

The key takeaway for both real estate owners and occupiers is that traditional models may no longer necessarily prevail.  Many tenants are already facing financial difficulties following the pandemic and, equally, many landlords are facing rental income deficits that may never be made up.  Once measures such as the furlough/job retention scheme and the moratorium on commercial lease forfeiture come to an end, there is likely to be another spate of tenant insolvencies and increasing numbers of void premises.  That all means that, in any future lease negotiations, potentially everything is up for grabs.  It is anticipated that, across office, retail and hospitality real estate markets, the most successful arrangements will be creative, dynamic, innovative and, above all, flexible for both parties.

How we can help

The best advice, whether you are a commercial real estate owner or [potential] occupier, is to speak to a real estate specialist to ensure that you understand exactly what you want to gain out of any occupancy arrangement; the level of flexibility that your business will require; the responsibilities that you are prepared to take on; the risks that you will want to avoid; and what are the best available options for achieving those aims.

If you are considering your options for letting or occupying commercial premises or if your business is renegotiating or renewing existing arrangements; and whether any potential negotiations may be prompted following the exercise of a break option, or whether they may be entirely fresh occupation negotiations or negotiations brought about purely by expedience or commercial necessity, Walker Morris Real Estate and Real Estate Litigation experts can provide specialist legal and practical advice to help you secure the best possible deal for your business.

For advice, support or even training on anything to do with flexible lease arrangements and/or (as a related subject) lease termination and exit strategies, please do not hesitate to contact Mark Byrne or David Manda, both of whom will be very happy to help.

[1] see Code of Practice for the commercial property sector during the Covid-19 pandemic

[2] some through full insolvency, some via CVA/administration rescue package stores closures: Arcadia Group, Oasis and Warehouse Group, Laura Ashley, Beales, M & Co, Chiquito and Frank & Benny’s, Pizza Express and Yo! Sushi, to name but a few

[3] A good example is the Chester Business Improvement District which (the Law Society’s Property Section reported in June 2021) has seen a significant change in direction over the last year, with 76% of new businesses being independently owned and 78% of closures coming from national chains or global brands

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