The Real Estate Law Review: Covid-19 and Real Estate: a UK Perspective
The uncertainty caused by the British electorate's decision to leave the EU has been put firmly into context by a truly catastrophic global event. At the start of 2020, it became apparent that the whole world was about to come under unprecedented attack by the rapid spread of a deadly new disease. What started off in a market in Wuhan, China did not take long to cast its shadow over every part of the globe. Covid-19 has affected the global economy like nothing this generation has previously faced. Not since World War II has the entire world been so adversely affected by one event. The pandemic has hit 218 countries and territories; every major jurisdiction has been forced into implementing a series of lockdowns and other measures to ensure the health and safety of its population while at the same time seeking to limit lasting financial damage. What started as a global health crisis has transitioned into an economic crisis that will leave its mark on the global economy long after the pandemic has run its devastating course. Lest we forget, covid-19 is first and foremost a human tragedy of epic proportions. At the time of writing, there have been more than 93 million cases and 2 million deaths. Although there have been some more positive recent signs with the development and approval of a number of vaccines, the task of manufacturing, distributing and administering an effective vaccine is enormous. This means that we are unlikely to be back to any sense of normality until the summer at the earliest. The process of dealing with the economic, social and political fallout will then be able to gain steam. By this point, the pandemic will have changed aspects of how we design, build and use buildings forever.
II REAL ESTATE
Real estate has arguably been hardest hit by covid-19 with a sharp decline in values across all sectors. Confidence in the property market had already been knocked by the uncertainty surrounding Brexit. The UK has finally completed the exit process and will have to forge its own recovery outside of EU membership. This may amount to a double whammy depending on how confident the rest of the world remains in dealing with an independent UK.
The retail, hospitality and leisure sectors were already in difficulty, as key players sought to adapt to changing consumer behaviour. These sectors have suffered the most, and many household names have joined the seemingly endless list of companies collapsing into administration. It has been a year to forget for traditional retailers, and the UK's high street will emerge from the crisis looking very different. The dearth of overseas visitors has hurt central London's normally resilient luxury retail and hospitality offering, and the resumption of international travel is eagerly awaited. Not surprisingly, the major supermarkets and the established online retailers and delivery companies have fared much better. From a broader economic perspective, it is worth noting that any increase in online shopping volumes has fallen well short of making up for the collapse in overall sales. A new lockdown introduced just before Christmas 2020 and affecting much of the country, including London and the South East, will not have helped those businesses hoping for a last minute seasonal boost.
The industrial sector has remained relatively resilient as competition remains strong for well-connected, high-specification distribution centres in the right locations. The logistics sector has continued to attract investment from both overseas and domestic investors, and this trend seems destined to continue. We are also likely to see the repurposing of redundant retail space for storage and distribution purposes.
Although the office market held up relatively well through the uncertainty of Brexit, covid-19 has had a much more significant impact on occupier demand as all businesses have revisited their UK and global requirements. At present, there is an overwhelming urge to reduce space as remote working has become an established part of how we all live and work. Although we are likely to see increasing vacancy rates in the second-hand office market, large corporates and major international professional services firms have remained active in their quest for new London headquarters buildings. In addition to incorporating facilities to meet the expectations of their workforce, as well as attracting customers and clients, the building must meet ESG targets and provide a safe and healthy place in which to work and do business. Occupiers are under increasing pressure to implement their green policies as part of their corporate identity, and, for many, the obvious place to start is their office premises. The gap between modern, safe and sustainable buildings and tired, second-hand space is set to widen. Connectivity, of course, remains essential. Although investment volumes have been affected badly, a resurgence in activity towards the end of the year indicates that London and the UK will remain attractive to overseas investors looking for a safe haven for their capital in difficult times.
III LEGAL IMPLICATIONS
The government has introduced a number of measures to protect businesses adversely affected by covid-19. Although the focus has been on the hospitality, retail and leisure sectors, protection has been given to all business tenants. The measures include affording protection from forfeiture for non-payment of rent, limiting the exercise of commercial rent arrears recovery (CRAR) by landlords and banning the use of winding-up orders. Originally implemented in April 2020, the measures have been extended three times and now seem likely to come to an end on 31 March 2021, a few days after the first rent payment date of 2021. The measures were introduced to protect tenants from aggressive landlords taking enforcement action to recover rents. However, in many respects it is the property sector that has found itself squeezed in the middle. Although the financial implications of covid-19 are no one's fault, without rent landlords are unable to meet their own commitments, including those to funders. A number of major property companies have been badly affected, particularly those with exposure to the hospitality, retail and leisure sectors. The government also introduced a new Code of Practice for commercial property relationships during the covid-19 pandemic. Although not compulsory, the Code encourages landlords and tenants to work together collaboratively to agree a shared recovery plan to help businesses to survive the crisis. The Code is not an excuse for tenants not to pay their rent, and landlords are not obliged to grant concessions. In practice, many rent payment plans have been agreed, waiving, reducing or deferring a tenant's rental liability for a set period. In many cases, the rent or part of it has simply been deferred and there will inevitably be further re-gearing negotiations when the deferred amounts start to become payable. The need for flexibility, including shorter contractual terms, break rights, options to renew and rights of pre-emption, has become an established part of a business's requirement for space. Rental structures are also evolving as landlords and tenants look for a viable model that meets both their requirements. This has led to a resurgence in the use of turnover rent models that allow an element of the rent to match the success of the tenant's business. The increasing importance of data, not only in relation to the calculation of turnover rents, but also in relation to the respective ESG priorities of the parties, has led to the emergence of a new breed of property professionals focusing on the obtaining and use of data as part of the landlord and tenant relationship.
Other measures introduced by the government include a business rates holiday for all retail, hospitality and leisure business that applies for the 2020 to 2021 tax year. A number of the major supermarkets that remained open throughout the crisis have agreed to repay the relief to the government. A stamp duty holiday introduced by the government at the start of the first lockdown to help support the housing market comes to an end on 31 March 2021.
Finally, and perhaps of most long term significance, is the government's proposal to review commercial landlord and tenant legislation to ensure that it remains fit for purpose as the UK contemplates its recovery from the pandemic. The main piece of legislation is Part II of the Landlord and Tenant Act 1954, which confers security of tenure on business tenants. Many commentators have called for a reform of the security of tenure regime on the grounds that the landlord and tenant relationship has changed significantly since the legislation was introduced nearly 65 years ago. The government will also look at different models of commercial rent payment and consider the effect of covid-19 on the property market generally. The pandemic has also forced the property industry to adapt to new working practices, and the use of electronic signatures and virtual completions has become an essential part of day-to-day transactions.
In 2021, the world has become a very different place. We have not witnessed a global crisis of this magnitude in modern times. To think, this time last year we were still fretting about Brexit. Although the covid-19 pandemic has well and truly put leaving the EU into perspective, Brexit does remain bubbling away in the background and potentially adds an additional layer of complication as we look to set off on the long road to recovery. Global markets have been encouraged recently by the positive news around the development of various covid-19 vaccines. The speed with which vaccines have been developed is astonishing, but those vaccines need to become widely available before confidence can return to the property market and wider economy. The task of manufacturing, distributing and administering sufficient doses of an effective vaccine will be nothing short of Herculean. As we look to begin the long journey to recovery, there will undoubtedly be opportunities for investors in the UK and global real estate markets. However, those investors will need to keep up to speed and remain agile if they are to take advantage.
1 John Nevin is a partner at Slaughter and May.