The current landscape of the 54 Act Renewal Market
“SHOULD I STAY OR SHOULD I GO”
With the pandemic ongoing, challenges persist in the lease renewal market, where tenants are facing continued business uncertainty and paying for space not currently occupied.
Pre-Covid office lease renewals were typically five years term certain. However, post Covid many businesses are uncertain about their occupational requirements, reflecting the disruption caused by the pandemic to the business and understanding the business landscape both in the short and medium term. Many businesses are still working out their forward strategy and as a result, tenants are delaying decisions, to consider their options around current occupational requirements, cost containment initiatives and flex working strategies.
LEASE RENEWAL CONSIDERATIONS
Tenants at lease renewal ideally want greater lease flexibility given the impact of Covid on business uncertainty. A tenant is likely to want a shorter term certain at renewal than at the initial point of acquisition, in any case. This is due to the tenant’s level of investment in the property. For office tenants, they are less likely to incur major refit-out cost on renewal than at the acquisition stage, as the initial fit out typically represents the major capital investment in the space.
From a landlord viewpoint, office lease lengths tend to be cyclical. In 2008, the longer lease length provided resilience to a weak occupier market. However, during the recent rising markets, long leases are less able to take advantage of the positive reversion opportunity in comparison to shorter leases. Shorter lease terms require landlords to be more proactive in their approach to asset management.
Supply shortages persist in the regional city centre markets which strengthens landlords’ negotiating position, whereas tenants are looking to landlords to be much more willing to co-operate, bearing in mind the lack of use during the pandemic. Whilst there is evidence of an increase in grey space, this is unlikely to impact on the current market situation.
"Pre-Covid office lease renewals were circa five years term certain. However, post Covid there are many businesses who are uncertain about their occupational requirements, reflecting the disruption caused by Covid to the business and understanding the business landscape both in the short and medium term."
LEASE RENEWALS UNDER THE ‘54 ACT
The lease duration is contained within Section 33 of the ‘54 Act and is interlinked with the options to break, be it landlord, tenant or mutual breaks and the regularity of those breaks. The parties are free to negotiate the length of term. The maximum term that can be ordered by the court is 15 years. The courts will give consideration to factors including the negotiating balance between the parties; the length of the previous term and tenant's period of occupation; intentions of the tenant towards the ongoing business and the equity as between the parties.
Witness statements are an intrinsic part to credibly understand the parties’ position for lease duration under the ‘54 Act renewal proceedings. Witness statements cannot be too generalist: in reality they should reflect the needs of the subject property. In our experience, office tenants will need to rely on credible witness statements, including board decisions or evidence of fact to justify the level of lease flexibility required. It would be difficult to mention the current circumstances without material evidence as to the consequence on the business and impact on the future property requirements. Landlords, on the other hand, may not want to renew with tenants on potential flexible terms and may look at the opportunity to repurpose assets to achieve higher values within their witness statements.
LEASE RENEWALS OUTSIDE THE ‘54 ACT (INCLUDING SCOTLAND)
Tenants who have no renewal rights are left in a precarious situation. They will need to determine both their business requirements and be aware of the strength of the occupier market at an earlier stage. This is despite a greater degree of uncertainty as a result of Covid. Landlords could exert pressure on tenants, but this will be down to the local occupier market dynamics and income risk.
Tenants are using the court process even more to stretch out the timeline for lease renewals as a result of Covid reflecting the increased uncertainty. Landlords are typically looking to delay discussions to avoid being locked into a “soft” Covid transaction which would impact on future renewals. Most landlords are working with tenants to understand their occupational needs. Tenants are considering options for flexibility whereas landlords require certainty. Where both parties are keen to avoid the time and costs, interesting compromises are possible by agreeing transitional arrangements.
As a feature of the current Covid market situation, parties are agreeing transitional transactions to allow both sides visibility on the evolving market. These tend to be either tenancies at will, so that there is no LTA protection, or slightly more commonly, temporary deals either at concessionary rent for a defined period with a reversionary period thereafter. This reflects the markets and evidence emerging once normality has returned, rather than setting the terms during the period of transition.
Where tenants have been holding over under a ‘54 Act renewal, then the transitional period can be created by an interim rent position, which again may be suitable to both parties and especially landlords to avoid being locked into unattractive terms. The downside is the likely dispute around the interim period and the lack of certainty that brings to both parties whilst negotiating the terms of the renewal.
Avison Young has been involved in a number of differing transitioning arrangements and one size does not fit all, especially bearing in mind the parties’ requirements, concessionary rental arrangements that have already agreed between the parties and the local market dynamics.
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