Rebalancing the Landlord and Tenant Relationship

…. could there be a positive outcome of Covid?

We all know that a balance of power is essential to a good working relationship but power inequalities seem to drive the workings of the property market in the UK. The products of imbalanced negotiations being historic sources of contention that lie at the very centre of the landlord and tenant relationship. Yet, our research shows that the retail property market might be experiencing the beginnings of a cultural shift, thanks to the pandemic.

Shifting power inequalities

The balance of power ultimately depends on conditions in the property market. When the market is buoyant the power to dictate the terms of a lease lies in the hands of landlords. When the market weakens, the tables turn and the power rests with occupiers. The strength of these power inequalities will vary over time and spatially as market conditions change.

Urban retailing centres in the UK have experienced mixed fortunes but in our city retail markets, at least until relatively recently, there has been a scarcity of well configured space in desirable locations. A shortage that has been fuelled by the relentless expansion strategies adopted by national and international retailers in the 1980s, 1990s and 2000s. This resulted in the power balance typically, although not exclusively, favouring landlords, which drove market rents up, pushed independent operators out to the periphery of the main retailing streets and resulted in the homogenisation of the retail offering in our centres and malls.

All this has been changed by rising operational costs and the tightening stranglehold of online retailing which have resulted in a contraction in occupation demand as larger retailers either have failed or been forced to restructure their store portfolio in a bid to embrace omni-channel retailing. Rising vacancy rates now mean retailers have much more power in the negotiation process. Retailers are well aware of the leverage they possess and have had no qualms using it to force landlords to accept major changes in the leasing model. Hence, the growing use of turnover-linked rents and shorter lease terms experienced in the market.

Tenant power plays in the market

The struggles of many multiples have been well publicised, both before and during the pandemic, and it is the larger retailers that remain in operation that have the greatest power. Landlords are well aware of the risks they are exposed to if these retailers, who often occupy large units or are anchors in shopping malls, close or relocate. It is these larger and savvy multiples that have the greatest leverage, and some have not be scared to exploit to improve their lease terms.

This approach may work in these extreme times but they are likely to be ineffective in the longer term. Large retailers, particularly those owning multiple brands, need to remember that shop investments involve substantial sums of capital which they are unprepared to tie up in owner-occupied units, typically because the returns are lower than the returns they can earn via their retailing operations. Investors (and this includes pension fund shareholders and savers) invest their capital in property assets in the expectation of suitable renumeration. If the investment continually fails to deliver their expected income and/or capital returns then they will reach a point where they say enough is enough. When this occurs, landlords will walk away from deals where they think tenants are demanding too much of them and even, as is increasingly happening, stop offering space for retail use. This only serves to reduce the accommodation options available to occupiers, which in time shifts the balance of power back to favouring landlords again.

Finding a balance

You will always find examples of acrimonious relations and badly behaved tenants and landlords. However, the recent use of tenant leverage and pandemic crisis seem to have facilitated a rebalancing in the landlord/tenant relationship as more landlords and tenants have found ways to work together.

Our research points to a fundamental change occurring here. Both landlords and tenants, in the majority of situations, seem to have realised that there is mutual benefit from working together, and there has been more willingness to do so. Interviewees, even before the pandemic, cite examples of partnership working, and landlords collaborating to support struggling tenants and being more flexible. An outcome of this change in attitude has been an improvement in transparency between both parties.

Will collaboration and partnership working remain post-pandemic? It would be nice to think so but your guess is as good as mine. Certainly, it is unlikely a perfect balance will be found in every deal. However, the improved working relationship we have seen more recently should establish a foundation to build upon. If both sides of the negotiation table respect the other party’s objectives and there is openness and a willingness to find a compromise, then a better balance in future deals should be achievable.

– Allison M Orr

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