Covid-19 has had an unprecedented impact for commercial landlords and tenants alike. Many retail and office lease deals have been put on ice over the past two months as occupiers adopt a “wait and see” approach. As we begin Phase 1 of the easing of restrictions, the hope is that the commercial property sector will start to rebound and that paused deals will get going again. New commercial leases will be drafted and negotiated with Covid-19 in mind.
The standard period for rent reviews in commercial leases in Ireland is every five years. When negotiating a new lease during this crisis, tenants may wish to agree shorter rent review periods with the landlord, perhaps even every twelve to twenty-four months. This will ensure that tenants do not find themselves paying a high rent for a five-year period should there be any further negative impact of Covid-19 on open market rents over the next couple of years.
The most common method of rent review in pre-Covid leases is according to the open market rent. Rent review by reference to changes in a tenant’s turnover are rare but are expected to become more prevalent over the coming months and years, particularly in retail leases. Turnover based leases were quite common after the economic crash in 2008. Turnover rent is a useful way for landlords and tenants to share the success and the risk of a trading premises. It allows the Landlord to monitor the tenant’s performance and take immediate action if performance drops. Some retail landlords may opt for a “ratchet” rent review provision which provides for the base rent to be adjusted by a percentage of the previous year’s total rent. While turnover based reviews may seem appealing to retailers, they should proceed with caution – the advice of their agent and their solicitor will be crucial here. Turnover conditions can be onerous and may not suit retail tenants with low margins.
In office or retail settings the landlord will typically insure the premises and the cost of the premium will be passed on to the tenant. Most pre-Covid commercial leases will have a rent suspension clause which allows for rent suspension where the premises is damaged or destroyed by an ‘Insured Risk’. Unfortunately for many tenants the scope of ‘Insured Risks’ in pre-Covid leases does not extend to infectious diseases such as Covid-19. It is expected that tenants will seek to include infectious diseases such as Covid-19 as an ‘Insured Risk’ in new leases going forward. This would allow for suspension of rent if the office or retail unit is closed as a result of any further lockdowns. There is currently no such insurance cover available in the Irish market so landlords should only commit to taking out the relevant insurance once it comes to the market.
Guarantees are common in commercial leases but may become even more so over the coming months and years. Some commercial landlords may insist that the tenant provides a suitable guarantor (usually a parent company) who agrees to perform all of the tenant's obligations under the lease for the entire term of the lease and potentially any renewals and variations of the lease. If the tenant is unable to pay the landlord can pursue the guarantor. Guarantees need to be carefully drafted and reviewed - guarantors should seek to limit the scope of their exposure where possible. Common limitations include confining the scope of the guarantee to a set period of time or a set amount e.g. one year’s rent under the lease.
We also expect to see an increased number of break options being sought by tenants in commercial leases. A break option is a right granted by a landlord to a tenant entitling the tenant to terminate the lease at a specified time in the future. Tenants may strategically look to schedule break options immediately or very shortly after a rent review has taken place. This means the tenant has an option to terminate the lease if the revised terms are unfavourable or unsustainable. Break option clauses should be very carefully drafted as they are strictly interpreted by the Courts.
We have extensive experience of working with both Landlords and Tenants to advise on the practical application of lease obligations and covenants. We are available to discuss any issues that may arise for you as a result of your evolving obligations as a Landlord and/or Tenant during this time of uncertainty. For further information, please contact Karl O'Brien on +353 1 639 3000 or visit www.leman.ie.
Commercial property sector 'expected to rebound' after Covid-19 – CBRE