The pandemic evidenced that legislation has limitations when it comes to achieving tenant-friendly lease arrangements. In this article, a group of LPC advisors reflect on why legislation cannot ensure tenant-friendly lease arrangements while also providing insights into the challenges tenants must overcome to negotiate a tenant-friendly lease arrangement. The conclusion is that tenants will achieve tenant-friendly leases by negotiation, not legislation, and that tenant-friendly arrangements are hard won.
Legislation has its limitations.
"Learn the rules like a pro, so you can break them like an artist." - Pablo Picasso
Rugby union is an exceptionally complicated game, made more complicated by the annual review of the rules of the game and the related changes that get made. Successful coaches and teams have two things in common: they influence the laws of the game and are quick to analyse and adapt to rule changes, such that they gain an advantage from rule changes at the cost of those who are less organised and have limited influence. There are similarities between commercial leasing and the attempt by the government to effect interim changes to the rules of the game to mitigate the pandemic's impacts on tenants. The landlords and leasing agent firms exert the most influence on the rules of the game, with landlords more adept at adapting to changes in the game's rules than tenants.
The pandemic was a change in circumstance that exposed the lack of tenant protections in leases, with no tenant provisions for occupancy cost reduction tied to impaired utilisation, necessitating government intervention via legislation to contain the pandemic's impacts on tenant enterprise. In essence, the legislation aimed at enforcing temporary changes in commercial leasing arrangements to achieve interim rent relief for eligible tenants.
Through effective advocacy, associations representing owners could contain the level of pain sharing accepted by landlords, such that the financials of major landlords evidence a surprisingly low reduction in income pursuant to the pandemic and the granting of covid rent relief concessions. The intended rental waivers were substituted in part or total by rental deferrals, which had the effect of deferring tenant pain rather than relieving the pain, whilst onerous landlord requirements for tenant financials slowed and obstructed rent relief. Furthermore, many landlords could trade off the granting of interim rent relief in return for extending the lease term and other negotiated outcomes favouring the landlord. It is fair to say that supply-side expertise and organisation effectively mitigated the pandemic's potential impacts on landlords and leasing agents.
Regarding Pablo Picasso's somewhat amusing comment, the limited impact of the Mandatory Code of Conduct for Commercial Tenancies illustrated that legislation has limitations when securing favourable arrangements for the tenant.
Tenant-friendly lease arrangements are negotiated.
"The most dangerous negotiation is the one you don't know you're in." - Christopher Voss
One of the most significant impediments to tenants achieving tenant-friendly leasing arrangements is the all-too-common acceptance by tenants of lease terms without an interrogation of the potential impacts, and without well-constructed negotiation. Tenants tend to over-focus on rent and the immediate effect of a lease agreement, with insufficient attention given to terms that increase the tenant's business risk into the future.
The pandemic evidenced this lack of attention to how lease terms can increase business risk into the future, as almost all commercial tenants in Australia had no lease protections for impaired use of the premises. Further to this obvious example, very few tenants negotiate landlord obligations and guarantees that provide a tenant with an assurance that they will continue to get the premises and features that caused them to enter into the lease agreement. So it is that many retailers do not experience the foot traffic that was marketed to them, while many office tenants experience a decline in the building services regime over the lease term. Other tenants provide both a bank guarantee and a personal guarantee in favour of the landlord without challenging the need for both, and other tenants accept a market-related face rental without negotiating an incentive. The fundamental problem is not knowing the depth and breadth of what can and should be negotiated by the tenant.
A positive tenant outcome from the pandemic is that the extent of the leasing risks carried by a commercial tenant has become more evident as lease obligations continued with no regard for the inability to utilise the leased asset causing tenants to question their lease terms, leading to and increased determination to achieve better outcomes via negotiation. At LPC we encourage all tenants to consider a lease as the right to utilise leased premises together with landlord guarantees tied to utility.
Tenants enter negotiations in the outside lane.
"Information is power. But like all power, there are those who want to keep it for themselves" - Aaron Swartz
The main reason tenants enter lease negotiations in the outside lane is that tenants have asymmetrical access to critical leasing data and information, and landlords exert far more influence on leasing norms to their advantage and tenant disadvantage. Landlords in Australia with commercial property assets are consolidated, well-organised for advocacy, and exert a powerful influence on leasing arrangements, whilst tenants are fragmented and focused on their specific tenant enterprise. For landlords, the property is their business, and their key success factor is ensuring predictable and growing passive income. Tenants need premises to operate their enterprise having regard to their business plan and risks in the future. Property is not their business, and they start in the outside lane when it comes to lease negotiation, particularly when the tenant is an SME with limited scale and covenant.
The challenge is for tenants to improve their lane position. In article 4, we will speak to changes in lease norms that are necessary to support tenant enterprise and accelerate economic recovery. In article 5, we will focus on how tenants can increase their negotiating power. For now, we remind tenants that the lease one ends up is a negotiated outcome and that everything is negotiable. We urge tenants to start each lease negotiation with the end in mind, which requires an in-depth review of one's business objectives, strategies, and risks into the future, thoughtfully considering the best fit accommodation requirements and lease terms. We wish all retail, office, and industrial tenants the best as you revisit your tenancy requirements.
About LPC & the LPC subscription service
LPC provides office, retail, and industrial occupiers with advice and services that make a difference to their accommodation arrangements and respective businesses. With no ties to investor property owners or leasing agents, we only represent occupiers, and our advice is free from any conflict of interest that would disadvantage an occupier. You will find the LPC subscription service most beneficial when identifying key terms for renegotiation and getting to the lease you deserve.
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