Innovative security measures for Landlords in a changing market


Author: Nick Mumby


Nick Mumby, Partner, Fladgate LLP (nmumby@fladgate.com)


 

With Brexit on the horizon there are an increasing number of stories in the financial press about struggling companies and fearful investors. Those affected range from well-known retailers to huge tech companies and it seems that no one’s position is as safe as once thought.  Against this back-drop, landlords are still trying to secure new tenants for new developments and refurbished buildings.  In such a volatile market, how can a landlord protect the investment value of its building?

In the past, if a tenant did not meet the required covenant strength, it would need to provide a suitable security package to the landlord. This would normally include either a rent deposit or a parent company guarantee (or both).

With the rise of the “post-millennial” company, in particular technology start-ups, landlords have had to become more creative as these companies tend to have overseas parent companies with no UK assets and are unwilling (or unable) to tie-up large sums of cash. They are often also young companies which are looking to take lengthy leases (up to 15 years) and expect to have the rent-free period at the beginning of the lease.

Consequently, the landlord has to balance the benefit of having a high-profile tenant against the potential risk of financial failure.

The pressure point occurs where the rent free ends and the (often substantial) rent becomes payable. Landlords are happy to allow a sizeable rent free (usually 9-12 months for each 5 year period), but do this on the assumption that they will have a tenant for the full length of the term.

What happens when the tenant fails during the first quarter after the rent becomes payable? Under normal circumstances, the tenant has benefited from 24-36 months of rent free, but the landlord is only able to recover a single quarter’s rent which had fallen due.

Upfront rent-free versus secure position

The tension between the tenant’s need to have the upfront rent-free and the landlord’s need to secure their position is clear.

Fladgate has advised landlords recently on similar scenarios and devised bespoke security packages. These have involved a letter of credit from a reputable institutional lender and a mechanism to re-invigorate the rent that would have been payable during the rent free period.

The letter of credit is provided on a diminishing scale, as the landlord’s exposure decreases and the tenant progresses through the term of the lease without default.

This provides the landlord with an “on-demand” facility in the event of default which is affordable to the tenant and does not require them to deploy large capital sums.

Each situation is different and there are various options which can be offered, expanding on these principles.

As they are bespoke commercial arrangements, it is also possible to ensure that they remain confidential by classifying the lease as an Exempt Information Document.

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