6 minute read 24 Apr 2020
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Mandatory Code of Conduct for landlords, or tenants?

By

EY Oceania

Multidisciplinary professional services organization

6 minute read 24 Apr 2020

In an attempt to level the playing field, the Federal Government wants landlords and tenants in rent negotiations to play by its new mandatory Code of Conduct. 

R
etail landlords will be subject to a mandatory code of conduct from this week after an industry drafted document was put before the National Cabinet on Tuesday. Landlords will be compelled to negotiate with tenants that are  eligible for the JobKeeper program; and have a turnover less than $50 million. Landlords will be required to reduce rent proportional to the trading loss in the tenant’s business and reduction must be in the form of rent waivers for at least half of the required amount.

Sydney real estate Partner Marco Maldonado says the Government’s intention around the mandatory code has been to level the playing field and ensure all landlords and eligible tenants had the same opportunities to negotiate. “But what’s happened with provisions such as the proportionality rules shows that more needs to be considered around the flow on effects of this.”

The proportionality rules require landlords to reduce rent by a percentage equal to the fall in the tenant’s revenue as a result of the lockdowns. That means if a tenant has lost 30 per cent of its business, then rent should be dropped by 30 per cent.

“Does the drop in turnover rule apply across the whole of the tenant’s business, or just to that asset? And is the landlord required to pass on the drop in rent to every location? What about online sales? Is it fair for landlords to only consider sales attributed to the physical presence? or will they be able to offset the online sales,” Maldonado says.”

“Also, if a tenant’s revenue drops, there are other components of input costs that also drop, such as staffing and product. These saving are not being considered. 

The intention is certainly right and there is definitely an urgency to it, but the lack of details around how it should be interpreted it is causing some angst. Mediation will be a major task.
Marco Maldonardo
EY Oceania Partner

The Code will be legislated and administered by State and Territory governments, and binding mediation will also happen under State and Territory rules.

Impact of the Code on assets post COVID-19

Maldonado says landlords, particularly those with retail tenants, are fighting the impact of COVID on three fronts – helping tenants stem the immediate bleeding; building a strategy for the post-COVID environment that can be put to boards; and digesting and implementing what the Government is doing, both through stimulus and the Code.

“And all of it is simultaneously with major knock on effects with differing outcomes depending on different scenarios,” he says. Markedly, the current crisis is expected to reshape retail shopping and consumer behaviour for some time to come.

“As well as negotiating with tenants in the short term, landlords will have to consider the credit worthiness of tenants being able to pay back the 50 per cent deferred rental and the impact on their ongoing viability. They will also need to consider what tenants they want and need in their centres when everything re-opens.

“Even more than that, they have to work out what their definition of a shopping centre will be and its ongoing role in the community,” he says, pointing to a growing expectation that once people are allowed out of isolation, there will be a clamour for experiences and re-socialisation.

“How will their centres look with the businesses that will re-emerge and will they be the same business coming out of this period as going in. These will also be key considerations which will affect their assets post-COVID time. It also means they may have to start thinking about different anchor tenants.”

EY real estate partner Richard Bowman says that so far, they have seen a pragmatic approach from both landlords and tenants.” But it will be important that both parties adopt a robust governance and methodology as the volume of requests within the market will spike now the Code has been introduced.

“It’s also important to remember that office tenants are different to retail tenants. The impact on office landlords will be felt long after the office tenants move back in. Retail we expect to see trade return quickly,” Bowman says.

“If landlords can help tenants out with office abatements and help reduce costs, employers can avert layoffs which are bad for the workforce and ultimately bad for landlords because vacancy rates will rise and rents will fall.”

The Mandatory Code of Conduct compels retail and commercial landlords and tenants to work together as shops and offices shut their doors during the coronavirus pandemic. The full text can be found on the Federal Government's website. Leasing principles include:

  • Landlords must not terminate leases due to non-payment of rent during the pandemic period (or reasonable subsequent recovery period);
  • Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100 per cent of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant’s trade;
  • Rental waivers must constitute no less than 50 per cent of the total reduction in rent payable, and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreement. Regard must also be had to the Landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement for a 50 per cent minimum waiver by agreement;
  • A landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response, or any other case-by-case deferral of loan repayments offered to other Landlords, with the tenant in a proportionate manner.

Knock-on effect from changed behaviour

The impact of the code is likely to be beneficial for tenants across the size spectrum, up to the $50 million revenue cap. It may be less beneficial for landlords, with the risk that mum and dad landlords and small business strip shop retail landlords may be compelled to enter disadvantageous agreements.

Neighbourhood strip shops are likely to become more important as we re-emerge from the social isolation of the pandemic. People may prefer neighbourhood shops where they can get in and out, and be in the fresh air with social distance and a fresh environment. Micro experiences may start to re-emerge as well as small local bars, cafes, and eateries where the crowds are known and local, Maldonado says. It means landlords of that size have to also be supported by this code as well, especially through mediation

The other effect COVID has had, is to cement the fact humans are social by nature. “We are never going to work from home full time, it is too much of a strain on individuals, but commercial office tenants will now work their space a lot harder.

“Businesses have realised that with the right infrastructure you can work from home, but they will need spaces for people to congregate,” Maldonado says. “This is going to have a significant impact on commercial landlords.”

He says they are expecting to see an increasing move towards repurposing assets, particularly in the cities as people adjust to working from home more. Even carpark operators are starting to re-think their utilisation of space. “Everything has a knock on effect and we’re starting to see that emerge now.” 

How best to support tenants while protecting your own interests

While the new Code sets parameters for both parties to follow, the Oceania Real Estate team have been advocating that landlords take a three staged approached with tiering and varying sunset dates, to accommodate different potential bounce back dates, as part of a Retail Support Framework  for rent negotiations.

Stage one includes a blanket, fast actioned response of a deferral (or partial deferral) for a month to give the parties room to assess impact on turnover and make plans.

Stage two would be tiered decreases based on the impact of coronavirus on turnover, giving tenants time to collate documents and landlords time to undertake a detailed cashflow assessment.

Stage three is an Occupancy Cost assessment, which should include considerations by the landlord of low long repayment will take for the tenant, will ensuring the tenant remains viable.

Landlords should also think about whether they want to put on the negotiating table the need for new clauses that provide the ability to restack tenants after businesses have re-emerged from COVID, or re-negotiate existing clauses that may determine reliance on other anchors.

Summary

Retail landlords will be subject to a mandatory code of conduct from this week after an industry drafted document was put before the National Cabinet on Tuesday. Landlords will be compelled to negotiate with tenants that are  eligible for the JobKeeper program; and have a turnover less than $50 million. Landlords will be required to reduce rent proportional to the trading loss in the tenant’s business and reduction must be in the form of rent waivers for at least half of the required amount.

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By

EY Oceania

Multidisciplinary professional services organization