COVID-19 impact on landlord/tenant

The further clarity presented on the expected rental waivers proposed by the government; appearing weighted in favour of tenants. In summary:

  • Landlords forced into negotiation;
  • Waivers in rental amounts must be a combination of a reduction and a deferral;
  • At least 50% of any waiver must be a reduction;
  • Rent waiver based on the % fall in the tenant’s business;
  • A tenant will have at least 24 months to repay the deferred rent;
  • Tenants must honour the lease.

Our initial thoughts

A real benefit for tenants which appears to come at a cost for landlords. Although there was also a “request” for banks to participate, there is no guidance or requirements for the banks to reduce or defer loan repayments. We also need to consider the impact on landlords where rent is their primary income (except it might give them access to other stimulus initiatives).  

What’s publicised as a way to keep landlords and tenants together, looks more like a win for tenants.

So why not provide more financial support? In our opinion, any financial assistance for rent/landlords is likely to face public perception that mortgage payments should also be supported, and we can only assume this is a scenario the government would prefer to avoid.

In the way it’s presented, it appears as forced rent reductions, ensuring landlords share the cost of trying to nurse the economy through COVID-19.

Key stakeholders:

For this discussion, the key stakeholders include the bank, the tenant and the landlord.

The Bank
Although not mandatory, it is becoming increasingly clear that the banks are willing to be flexible when it comes to mortgage repayments. However, in our experience so far, the flexibility comes in the form of deferred principal and interest. The banks are not merely going to forgive six months’ worth of mortgage repayments, which means the landlord is still going to be up for the full cost of debt going forward. With interest capitalised, there will be a higher cost to the landlord to defer its liability.

Banks also appear to be open to reducing interest rates, which could provide a further opportunity for landlords.

Of course, negotiating with the bank to reduce interest and defer payments on business debt is also an option to tenants that will allow them to continue to pay the rent. Landlords should ensure it is not just them dealing with the bank.

The landlord
The landlord is in the stickiest position (solely from the rental relationship point of view). They need to keep tenants, but they also need to pay the mortgage. There are a considerable amount of uncertainties facing landlords at the moment; obligations to pay the debt, a likely reduction in property value, struggling tenants unable to pay rent, finding new tenants at similar rental rates (if at all).

Landlords should be speaking to their banks already. There are good interest rate deals to be had, and deferrals are possible. Unfortunately, we can’t see a scenario where banks would reduce the debt owed to them.

When it comes to dealing with tenants, you need to understand their situation. Are they just trying to take advantage of the current situation to reduce rent, or are they in reality, struggling? How flexible are you willing to be in either scenario? If your tenant is not receiving JobKeeper payments, then you don’t have to reduce rent. Make sure you have confirmed that your tenant meets the reduction in trading requirements.
The JobKeeper requirements are:

  • Turnover reduced by 30% (for businesses with <$1bn in turnover) or 50% (for businesses with >$1bn turnover);
  • Turnover for charities or NFPs only needs to reduce by 15%
  • Based on estimates; and
  • Can be claimed for six months from 30 March.

If your tenant is just kicking the can down the road and goes bust in 6 months, then it’s your loss. Further clarity needs to be offered on what happens if a tenant estimates a fall in turnover of 30% but does better than expected. Landlords should be thoroughly reviewing forecasts and estimates prepared by tenants.

Of course, landlords need to be conscious of the compounded impact reducing rent has on their short-term cash flow plus the value of their property. In our opinion, expected rental yields are likely to stay the same, which means any reduction in rent will, in our opinion, translate to a decrease in property value on the assumption the reduced rental amount is not recovered after the impact of COVID-19 has passed.

On the upside for landlords, if you have a tenant that doesn’t meet the JobKeeper requirements, it would appear you don’t have to negotiate. Also, there is unlikely to be a lot of options out there for tenants to move because the government is mandating tenants negotiating with landlords must honour their leases. While we are on that topic, making a tenant abide by the terms of a lease is hardly a “benefit” to landlords!! If a landlord does reduce and waive rent (whether required or not), they should seek an extended lease term from the tenant. Also, any adjustments should be made with monthly reviews so lease terms can be adjusted regularly to reflect the performance of the tenant.

Out of curiosity, we benchmarked the established house price index across the eight capital cities to the All Ordinaries index from 2002 to now. While we don’t have current house price data, the chart clearly shows that house prices significantly outperformed during the GFC when compared to equities. Could this happen again? We are less optimistic now landlords are pressured to reduce rent. Perhaps another negative observation from the chart below is the substantial run property prices have had since 2013 (driven by NSW and VIC). A modest pullback in pricing would not look unusual purely from a trend perspective.
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Landlords should also prepare themselves for potential growth in working from home and a decline in the need for floor space for the same number of employees.

Related party tenants and SMSF is also an interesting issue. What is commercial rent in this market? Can market rent be breached accidentally in the current environment? Luckily the answer is “no”. The ATO has provided commentary that compliance action won’t be enforceable when it comes to related party rental contracts in 2020 and 2021.

The tenant
The tenant currently appears to hold all the cards, albeit while potentially struggling to keep themselves afloat. Tenants have been given protection from eviction for six months if COVID-19 impacts them. If you’re receiving JobKeeper payments, then you qualify for a rent reduction.

Tenants also have the benefit of uncertainty when negotiating rent reductions. Based on estimated turnover, rent reductions will be driven by tenants to guide the amount of waiver applied.

Even if you do not qualify for jobseeker payments, you should be negotiating rent reductions. Keep in mind that a landlord still has to pay a mortgage, and they may not be able to be as flexible as you hope. If you do receive a favourable rental result, you should consider extending lease terms as a trade-off. Also, don’t lock yourself into fixed future rent increases and make sure you allow a rent assessment in 12 months. Its possible rents reduce over the next 12 months.

What does the future hold?

Solutions will be unique to each situation. Landlords holding property exposed to hospitality will need to be much more flexible than those in other sectors. However, if we do fall into a recession (which should be the base case assumption), there is unlikely to be an industry that won’t be impacted.

Now, more than ever, those managing their own properties should be seeking as much information and support as they can. Maybe even enlist the services of an expert.

Unfortunately, all the risk is with the landlord. Landlords should receive compensation for taking that risk (and applauded for saving the businesses they are supporting). Instead, it looks like landlords can expect a reduction in rental payments and a reduction in their property values. If rent payments are to reduce by 15% (50% of a 30% fall in turnover), then it’s fair to assume that property prices are also going to fall by 15%. Given the number of properties that will be impacted by this, we suspect all property owners are going to suffer a reduction in values and rents.

Given expected market conditions, landlords were probably going to cop a reduction in rent over the next 12 months in any case. This may be the catalyst to reset rent so that all the tough conversations are out of the way early.