An uptick in early lease surrenders is likely as businesses adapt to Covid-19, prompting a call for tenants and landlords to better understand the ‘make good’ provisions in their leases.
Most commercial property leases in New Zealand contain clauses that oblige tenants to reinstate their properties at lease end. These ‘make good’ obligations are met by either undertaking physical works or compensating the landlord with a financial settlement.
David Guy, Managing Director of Building Consultancy at Colliers, says there is little doubt that ‘make good’ is an emotive subject for landlords and tenants, even when the property sector is performing well.
“As Covid-19 continues to impact the way businesses operate, it is now more important than ever to understand what ‘make good’ provisions mean for both landlords and tenants.
“Office teams working from home, online meetings and an uptick in online retail will inevitably mean that that many occupiers will reconsider their property needs.
“This will almost certainly lead to early lease surrenders and consequential discussions over ‘make good’ obligations.”
Guy says from his team’s experience, large-scale tenants – some of which have dedicated property teams – are well advised and highly aware of the full extent of their leasehold repair exposure.
“However, smaller businesses are all too often blissfully unaware of the sting in the tail that waits at the end of their property lease.
“It’s important for tenants to know the facts in advance of opening up those difficult discussions with their landlords. Forewarned is forearmed and a ‘make good’ assessment will help identify the extent of their leasehold repair exposure and provide strategic advice on how to minimise it.”
Equally, Guy says that well-advised major landlords are often acutely aware of the value of ‘make good’ within their lease portfolio.
“Smaller landlords, or those who simply haven’t sought professional advice, often either don’t know about ‘make good’ or have little appetite to enforce it.
“Consequently, they may find themselves financing a much larger share of refurbishment costs, necessary to re-let their buildings in a market with increased vacancy.”
Guy says the construction sector will undoubtably be hit hard by Covid-19.
“A reduction in the availability of building contractors may mean that tenants who need to exit their leases quickly have no option other than to negotiate a financial settlement.
“Conversely, with a considered lease-exit strategy and longer lead times, it may be possible for your advisors to engage with contractors, who are willing to accept reduced profit margins and work to find economic solutions.
“It’s our experience that landlords almost always prefer a financial settlement. The ability for tenants to complete physical works, or at least offer to do so, will take away an important negotiation tool from them.”
Guy says memories will last long beyond the Covid-19 pandemic and there is little doubt that those landlords who take an unreasonably hard line on ‘make good’ will suffer reputational damage.
“It’s equally true that tenants who allow their companies to fall over rather than work out a solution with their landlords may find themselves perceived as ‘high risk’ when the property sector recovers.
“When it comes to ‘make good’ settlements, it is our experience that ‘reasonable’ claims settle relatively quickly. However, when either side takes an ‘unreasonable’ stance, the matter becomes unduly lengthy and expensive.
“Property leases generally include provisions for dispute resolutions, but our view is that these are often the wrong tools to resolve ‘make good’ disputes. They are expensive to implement and take a long time to reach conclusion.
“With the right advice, a balanced, fair and reasonable ‘make good’ assessment can be drawn up and agreed in good faith between the parties. These should include innovative commercial solutions that fit the needs of both parties.“Ultimately, we are all in this extraordinary global event together and the economic impact on the property sector will be severe. A spirit of collaboration, understanding and fairness between landlords and tenants is needed now more than ever.”