Fixed or variable commercial rent – cool heads called for

As thousands of businesses enter uncharted waters post Covid-19, one of New Zealand’s most experienced property, tourism, hospitality, and business experts is calling for cool heads over coming months.

Adrian Chisholm, founder of New Zealand-wide business TourismProperties.com, says landlords and businesses need to work together in good faith to help stem the tide of closures and redundancies.

Advocating some “good old-fashioned common sense and sensible solutions”, the Queenstown-based businessman is speaking from 45 years of previous ownership of a wide range of tourism businesses and as a former landlord and tenant.

But currently without a foot in either camp, his independent ‘helicopter view’ of current woes advocates that commercial landlords and tenants may need to accept that rent is no longer a fixed but a variable cost for the foreseeable future.

“They need to accept they’re ‘joined at the hip’ and allow common sense to prevail,” he says. “In my opinion the solution is to adopt a Variable Rent Programme (VRP).

“Within 72 hours, tourism-related businesses went from being on steroids to full cardiac arrest. For commercial tenants, strangled by rental obligations in an environment where there’s no income, the outcome is obvious and disastrous.

“On the face of it the landlord may be protected by rental obligations and personal guarantees in leases, but in fact there’s little immunity from current business risk.

“Without a tenant paying rent or outgoings to cover rates and insurance premiums, there’s significant income disruption and potentially a prolonged period of vacancy.”

Adrian says landlords should be under no illusion that if good tenants fall over, there’s no queue of prospective occupiers, resulting in illiquidity and value erosion to the market value of the property.

“There’s merit in the argument that some rent is better than losing a good tenant and the prospect of no rent at all, and other options include Government-sanctioned bank loans which require approved cashflow statements and business plans which are currently nearly impossible to establish.

“What’s required is an open book process where the tenant pays an adjusting percentage rent to turnover.”

Adrian says this works by the business’s actual percentage turnover being confirmed at the end of each calendar month, perhaps by an accountant, and that proportion applies as the adjusted rent payable for the following month.

“This continues until the tenant gets back to the prescribed rent in the current lease. It’s a process that’s well advanced in Australia,” says Adrian.

The transparent process of the “open book” rental calculation being certified could potentially be done using the free services of the Regional Business Partner Network.

Adrian says that historically, market rents for accommodation, hospitality and retail tenancies were firstly assessed by direct comparison ($/sqm or $/room) but they also needed to fit within a framework of perceived affordability.

“What that means is that rents also needed to represent an acceptable percentage of turnover or net income. Ultimately a prudent tenant will only offer a rental that is deemed to be sustainable and a landlord will accept this necessity if they wish to lease the premises.”

Accommodation rents generally equate to around 22% – 28% of expected turnover, food and beverage/hospitality business rents generally equate to 6 – 8%, and retail percentage turnover rents vary widely, depending on the business sector.

Most current leases have a ‘ratchet clause’ that holds rent at a certain level and may need to be restructured to provide an acceptable level of certainty and confidence for both parties to remain committed and further invest in the premises.

“The ratchet clause is a draconian blunt instrument that should be history,” says Adrian. “Some landlords are putting their heads in the sand if they think otherwise while tenants aren’t sleeping at night if they’ve got this hanging over them.

“Another consideration is whether the landlord has enough protection from losses. Where the business is insolvent, the guarantor is insolvent and there’s little goodwill in the business. Then the landlord and the lessee are truly joined at the hip because both are facing losses.

“If the lessee and guarantor are sound and the lease has value (such as a good motel), then landlords can happily dig their heels in and expect full payment. There’s little financial motivation to make concessions.

“We also need to separate lessees who have a cash flow problem against lessees with a viability problem. Cash flow problems can be solved by deferrals, but viability problems call for agreed reductions.”

For a full outline of the issues and solutions go to: https://www.tourismproperties.co.nz/variable-rent-programme-vrp/

For further information:
Adrian Chisholm
Director, Tourism Property Brokers Limited t/a TourismProperties.com
Email: [email protected]
Mobile: 021727888