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What next for landlords and tenants?

The miserable economic climate of the past five years is changing the landlord and tenant relationship. Security through fixed uplifts is the new order of the day, says London law firm Boodle Hatfield's Andrew Wilmot-Smith.

Recent transactions in the retail and grocery sector reveal the gap between marketable retail investment assets and the rest, and how successful landlords and successful tenants usually find each other in time.

Investors seeking long income streams and top grade covenants are attracted by the grocery sector's strongly defensive characteristics, especially in the smaller formats. Lettings in the sector show an increasing trend towards fixed uplift or capped rent reviews. Unlike open market rent reviews, fixed uplifts give landlords certainty of income and, if sufficient assets of similar income profile can be packaged up, the opportunity to participate in the slowly restarting securitisation market. For tenants, fixed uplifts provide certainty of another kind, smoothing the valuation of leasehold liabilities on the balance sheet, and act as a hedge against volatility in food and petrol prices.

Listed retail tenants with global exposure and established credit ratings remain highly attractive to the diminishing number of banks prepared to lend. There has also been a marked trend in the lower to middle end of the market for purchases with pure equity, especially by overseas buyers, where minimal interest rates, domestic political risk and currency uncertainty make holding cash unattractive. For an initial outlay, an investor prepared to take modest development risk in a tried and tested field can forward fund and lease back retail sites, and enjoy 20 year income at attractive yields.

Perhaps counter-intuitively, investors seem prepared to hold portfolios let to a narrow selection of household names, knowing that the tenant businesses themselves are highly diversified.
The other end of the retail investment sector is another story entirely. Changing consumer attitudes in austere times have dragged whole tenant sectors into the category of discretionary spend, or involved retailers in a race to the bottom on pure price that few can win. Everyone needs food, but outside Bond Street not everyone needs expensive handbags and lattes, and cut-price clothes can always be bought somewhere else for less money.

Landlords can help tenants 'voluntarily' by allowing monthly rental payments, and demanding less stringent rent deposits from new tenants or assignees. In reality, the tenant's bank is simply not prepared in any event to put up 12 months' rent in cash, ring-fenced in due course from the tenant's administrators. But such leniency is essentially cosmetic when the tenant's business model is broken.

For such landlords, tenant diversity is key, plus the flexibility (if the bank allows it) to back interesting start-ups with chain potential, but no trading track record. Alternatively, it is time for landlords to accept that much of the UK's tertiary retail sector, if it is to have a future, is in any sector but retail. Working out a long term strategy in this sector is management intensive work, and not all funding banks have the patience for it.

This article by Andrew Wilmot-Smith first appeared in Property Week on 10 February 2012

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