Tenants seek flexibility 28th October 2012

Almost 60% of leases (weighted by rent passing) that expired by the end of last year had not been relet by Q2 2012 – the highest level in the last decade – according to stark research from IPD and Strutt & Parker.

The report finds that landlord difficulties are being exacerbated because struggling tenants are also increasingly exercising their right to exit a lease early with 48% leaving their leases at break – again, the highest proportion in over 10 years.

The IPD/Strutt & Parker Lease Events Review measured over 93,000 leases across 2011 and 2012 to better measure the effect of lease events (lease expiries, break clauses, defaults and vacancy rates) on commercial property investor cash flows.

Rental values are still over 9% below their 2008 peak levels, and tenants, particularly in the office sector, are eager to take advantage of lower prices offered. Over the 12 months to June 2012, net income has grown by only 0.2%, while inflation was 2.8%. Only 19 percent of leases that expired were renewed at a higher rent than previously.

The report finds some positives in the retail sector, where the increased incentivisation of landlords, through lower rents, rent free periods and bespoke rental increases meant 46% of retail tenants decided to renew their leases – compared to only 20% in the office market.
Landlords have been increasingly cooperative in regards to the struggling high street. Rent-free periods average over eight months, while newly signed lease lengths, when break clauses are taken into account, are under six years. As a result, only 25% of tenants decided to break their leasing contracts when given the opportunity, against 57% in the office sector.

Greg Mansell, head of research at IPD said: “The struggling UK economy is making it extremely difficult for UK commercial property landlords to keep their tenants, and this has enormous implications for income streams – which are the life blood of the sector. “Active management remains a challenge and one that no landlord can ignore. Understanding lease event trends is essential to constructing an informed asset management strategy, particularly for understanding the differences between sectors.

Retail has produced more favourable metrics than offices and industrials, supporting the view that not all tenants are looking to vacate at the first opportunity and many still want to secure their current pitch for an extended period.” Stephanie McMahon, head of research at Strutt and Parker said: “Landlords are generally seeking to maintain their income streams and need to engage early with occupiers to understand if lease and rental negotiations can result in tenants staying in situ, or perhaps moving to another, more appropriate building, within a landlord’s portfolio. “Where tenants have vacated their space opportunities have arisen in some instances for landlords to seek change of use.

London markets in particular have witnessed investors looking at attractive returns from residential and converting quirky, secondary office space into well located homes.”