Tenant friendly commercial lease arrangements are not the norm

20 Sep 2021 03:46 PM

This is part 1 of our series on ‘Getting to tenant friendly lease arrangements’

The pandemic highlighted how harmful ‘tenant unfriendly’ lease arrangements can be for occupiers as lease commitments continued despite interrupted usage of the leased premises.  In this article a group of LPC advisors share their insights into why ‘tenant friendly’ lease arrangements can be elusive for many commercial occupiers.  In the follow-on articles our advisors share vital lessons learnt about how to navigate the road towards more ‘tenant friendly’ lease arrangements.


Perspective 1 - ‘Know your opposition’

“We do not pass to move the ball, we pass to move the opposition”
-    Pep Guardiola (Manchester City coach - 2016 to present)

For a commercial tenant to get to a tenant friendly lease arrangement it is vital that one knows what one is up against.  At LPC we like Pep Guardiola’s perspective, because our aim is to ‘move the opposition’ so that more and more commercial occupiers end up with more ‘tenant friendly’ lease arrangements that better support their respective organisations.  We are unashamedly biased in favour of commercial tenants who need all the help they can get in an industry largely controlled by the supply side, and our strategies to ‘move the opposition’ are built on an understanding of the players and the rules of the game, with due recognition of these facts:

    That the interests of owners and tenants are diametrically opposed, such that every benefit that one party negotiates is normally a negative for the other party
    That the supply side is concentrated, and the demand side is fragmented, such that owners have far more influence on the norm for lease arrangements,
    That there is a lack of transparency about leasing arrangements, such that landlords have far more access to and control over leasing terms than tenants do.

Acknowledgement of these facts help an occupier when formulating a strategy to optimise a multi-site portfolio of leased premises and / or when implementing a transaction strategy relating to a single site requirement.  An understanding of the structure of the commercial leasing sector and of the vested interests of the players, enable an occupier to better understand the opposition and their strategies, and to better appreciate how to ‘move the opposition’ in the direction of more tenant friendly outcomes.

To help commercial tenants overcome the disadvantages of fragmentation and the lack of transparency at a macro level, LPC partners with associations, franchisors, and property heads of multi-site occupiers to facilitate a level of focused consolidation that increases tenant leverage for specific groups of tenants.  This strategy helps ‘move the opposition’ towards more ‘tenant friendly’ lease arrangements for that specific group of tenants.  In this way, LPC helps to contain the power of investor landlords and leasing agents such that negotiated lease arrangements are more supportive of the tenant’s business, having regard to their business objectives and business risks.  

If you are a leader of an organisation, or a franchisor, or a head of property for a multi-site occupier, then you are most welcome to speak to us and we will help you achieve more tenant friendly leasing arrangements for your specific organisation. 

Perspective 2 - ‘Think of a lease as buying utilisation with a warranty’

“A lease is a contract outlining the terms under which one party agrees to rent an asset—in this case, property—owned by another party.”
-    https://www.investopedia.com/terms/l/lease.asp 

There are many definitions of a lease, but they all highlight that there is an agreement between a lessor and lessee that sets out the terms for the lessee’s use of the leased asset.  Our second perspective is that the way an occupier thinks about a lease will have a significant impact on how tenant friendly or tenant unfriendly the negotiated lease terms are.  At LPC we think of a lease as buying utility of a leased asset together with landlord warranties relating to the utility. This perspective is invaluable for a lessee, and it requires further explanation and comment.

It is in the interests of investor property owners and leasing agents to secure tenancy arrangements that transfer the risks of ownership to the lessee for the term of the lease, whilst retaining the benefits of ownership.  In practical terms this implies the negotiation of lease terms that secure favourable and predictable income streams for the landlord, regardless of the potential for changes beyond the tenant’s control that may negatively impact the tenant’s utilisation of the leased premises.  The most obvious current example of landlords preserving income streams whilst transferring the risk of ownership to tenants, is that very few tenants in Australia had lease terms that provided for reduced rent in the event of a pandemic or another interruption to the utilisation of the leased premises.  Aside from government intervention and / or landlord goodwill, tenants bore the full risk of the pandemic impact on utilisation.  The stark reality is that thousands of Australian businesses will not survive the pandemic as their tenancy obligation continued unchanged whilst their premises utilisation was severely restricted.

There are numerous other examples of the leasing norm whereby lease terms do not protect the tenant when there is a change in utility or appeal of the leased asset outside of the tenant’s control.  We regularly come across tenants that are disadvantaged by property owner works that diminish the attraction and utilisation of the leased premises during the term, but who entered a lease without appropriate protections for such circumstances.  More subtle examples include degradation in the leased asset attributes (e.g., Foot-traffic / building grade / infrastructure / building efficiency etc) that were initially marketed to the tenant, and which influenced the tenant’s decision making, and the absence of provisions in the lease that protect the tenant from degradation. 

Whilst the norm for commercial leases is that risks of ownership are carried by the tenant during the lease term, the benefits of ownership are retained by the landlord.  The most significant example of this is that the norm for commercial leasing in Australia is that the property owner is the sole beneficiary of the growth in the value of the leased asset during the leased term, despite the value created by the lessee. It is our view that it is reasonable that tenants participate in the growth of the value of the asset as their tenancy and covenant contribute to this growth, and that the extent of the lessee participation in the growth in the value of the leased asset should reflect the value of the tenancy.

These examples illustrate why it is important that tenant’s ‘think of a lease as buying utility of a leased asset with property owner warranties relating to the promised utility,’ for this perspective will take the lease negotiations in a direction that better aligns the lease terms with the business objectives and risks.  The outcome of this perspective will be a lease with stronger property owner obligations relating to the attributes marketed to the tenant, and a lease with a greater sharing of the risks and value creation associated with the lease.

Perspective 3 - ‘You get what you negotiate’ 

“In business as in life, you don't get what you deserve, you get what you negotiate”
-    Chester L Karrass 

‘You get what you negotiate’ is a simple statement but it is an exceptionally powerful perspective when it comes to negotiating tenancy arrangements. We find that this perspective prevents us from accepting the norm as a given and drives innovation and creative problem solving, and more tenant friendly lease arrangements.

At LPC we give a great deal of attention to defining what tenant friendly lease arrangements look like generically and for each client, and then we strategize and act to achieve these arrangements.  Underpinning our lease negotiation approach is the recognition that there are very few rules relating to leasing arrangements (although the retail sector has a regulatory framework) and that one does ‘get what you negotiate’.  Our overriding aim is to negotiate tenancy arrangements that de-risk our client’s business. 

The question is what should a commercial occupier focus on to improve their lease arrangements?  At LPC we focus our efforts on negotiating improvements from the tenant’s perspective in relation to cost, risk, flexibility, obligations and guarantees.  These 5 areas help us analyse what is most important to the client and their business, and this analysis provides the guiderails for our negotiations.  As always, the ‘devil is in the detail’.  The items that we give detailed attention to in most instances include the valuation terms that govern the rental if an ‘option to renew’ is exercised, the obligations of the property owner relating to matters that make the premises work for the tenant, the ability to exit or to contract or to expand the tenancy, and the tenant rights related to usage and modification of the premises. The impacts for the lessee of an improved landing point in these areas is significant.

Conclusion

In summary, our negotiations are underpinned by the concept that a tenant is ‘buying utilisation’ of the premises via the lease. In this regard we seek property owner guarantees that the attributes that made the premises the preferred choice initially will be sustained, and we seek provisions that amend the occupancy cost when utilisation is impaired for reasons beyond the tenant’s control.  

Look out for the next article in this series and all the best as you navigate the pandemic.

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. Our single purpose is to help commercial occupiers optimise their accommodation and tenancy arrangements. You will find the LPC subscription service most useful when it comes to identifying key terms for renegotiation and getting to the lease you deserve. 

Contributors to this article:
-    Ken Lam 
-    Gillian Heath
-    Julian Kurath
-    Michael Raymond
-    Dylan O’Donnell
-    Adrian Gerber
-    John Reed 

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