From a real estate perspective, this has had a significant impact on rents. Landlords are finding that uptake of retail space and occupier demand is slowing - leaving them with vacant premises and a weakened income stream. Lockdowns and forced closures of the retail sector has hit the bottom line for the majority of tenants. This, together with supply chain issues, labour issues and rising costs, has created an incredibly difficult period of trading for the consumer sector.
With lockdowns forcing customers and the consumer sector alike to embrace online shopping in a way that became a must have rather than a nice to have, it has also raised considerable questions about the right balance for a retail property portfolio in 2022 and beyond. Are the old high footfall locations still the right ones, particularly if a significant percentage of people work from home? Does the store estate allow click and collect to be integrated and is it eCom friendly? Or is it time to start to reshape the portfolio and cut losses in certain areas?
In order to retain tenants, landlords have to date been amenable to entering into rent concessions to preserve some income streams and waiving arrears to keep their tenants from shutting up shop. For example, in the UK the Government introduced legislation to prevent landlords from forfeiting leases and pursuing tenants for rent arrears in the courts. The UK Government extended the forfeiture moratorium for the fifth time to 25 March 2022 and the winding up moratorium to 30 September 2021. The Government also announced new legislation to ringfence “COVID debts” and provide guidance to tenants and landlords to agree repayment plans. There is also a formal arbitration process introduced for “COVID debts” up to 25 March 2022. Beyond that however, the position may start to look very different and landlords may much more aggressively start to assert their 'rights'.
Unfortunately, no moratorium was adopted in France which has resulted in a very significant increase in litigation between landlords and tenants, as well as landlords using bank account seizure mechanisms to put pressure on tenants and obtain payment of full amount of rents. Tenants have however avoided insolvency as the French Government has implemented strong support regimes. Consequently, the volume of insolvency in France in 2020 and 2021 actually decreased and despite the aggressive landlord behaviour, more retail premises operate now than in 2019.
What happens as government's start to reduce support?
As countries start to wind down the support regimes that have been put in place during the pandemic this may result in an increase in tenant insolvencies. But, that position is not consistent across Europe. In France for instance, the situation remains stable due to a robust post-Covid economy recovery and higher growth figures than forecast. However, economist reports have already outlined the risk of an increase of insolvent companies in 2022.Landlords and tenants alike will have some difficult decisions and conversations ahead. We anticipate that there will be deals to be done as the alternative outcome for the landlord i.e. an insolvency, is usually a worse outcome than an offer put forward by the tenant.
Insolvency is not an instant event and it can take months, or even years, for businesses to become insolvent. The two main tests for assessing insolvency are the balance sheet test (are a company's liabilities greater than its assets?) and the cash flow test (does the company owe more money at any one time than it could pay?). If the answer to one or both of these tests is 'yes' then this should start to ring alarm bells. Even if the answers to these tests are 'no' but tenants are cash poor, functioning at the limit of their overdrafts, are experiencing difficulties in paying employees or are under pressure from creditors, these should be treated as early red flags and signs of potential trouble ahead.
So how does a tenant deal with this?
There are two main options: a restructure or a refinance.
A restructure usually involves significant changes to financial or operational structures, typically whilst under financial pressure. In several countries, the insolvency regime includes a simplified restructuring procedure allowing for a quick and easy way to reduce debt quickly entering into negotiations with creditors while ensuring protection of the debtor's assets from enforcement and termination of key agreements by business partners. This is the case in both Poland and France for example, where this simplified restructuring procedure is the most used in the retail sector, and in particular adapted for negotiations between tenants and their landlords.
Refinancing can be done in one of two ways; debt financing or equity financing. Debt financing involves securing a loan to (ideally) consolidate and pay off existing debts. In theory, this should give the tenant some breathing space and may even be done in tandem with a restructure. The risk here is that interest rates are likely to be high, given the liquidity of the tenant, and compound the problems further. The other alternative is to look for equity funding. This would involve a finance house or another company acquiring the shareholding of the struggling tenant. Whilst this may keep the tenant afloat, such an acquisition would generally be below market value. If refinancing is a viable option, conversations should be opened up with potential funding partners as soon as possible if the insolvency tests set out above are triggered.
If a tenant is unable achieve a consensual solution with a landlord via the new arbitration route, as the payment of the arrears amount under the process would render it insolvent, or future rent is unaffordable, there are formal restructuring processes available, including (but not limited to):
- CVA;
- Restructuring Plan; and
- Administration.
Additionally, tenants may consider new ways to maximise their working capital and minimise costs to help them manage any funding requirement resulting from payment of “COVID debts” and other arrears which have accrued.
But is a crunch inevitable?
With forecasters predicting a strong bounce-back (and, until Omicron at least, a strong Christmas 2021) there may be brighter days ahead. For example, forecasts in Poland suggest increases in retail sales of 4.9% annually until 2023 and 3.3% annually until 2025, with 90% of purchases still being made in physical retail stores. In the UK, whilst retail rents are expected to fall, the Government has introduced a code of conduct to encourage landlords to enter into payment plans and waive arrears for tenants to return to a level playing field. Whilst future government intervention may soften the blow for struggling tenants, don't ignore those red flags! Take this opportunity to reconsider the size and shape of your property portfolio and make it right for 2022 and beyond.
If you have any questions or concerns, or would like to talk to one of our global consumer sector real estate experts please get in touch.
Authors: Sophie Hughes, Bartosz Ostrowski, Natasha Atkinson and Carole Arribes.
