COVID-19 impact on commercial property leases

The purpose of the COVID-19 Commercial Leasing Code of Conduct, announced on Tuesday, 7 April 2020, is to provide order between tenants and landlords, and to avoid a Lord of the Flies scenario during the coronavirus lockdown, where tenants don’t pay landlords, landlords evict tenants, no one can repay the bank (and we all dance like savages around a fire on a deserted island).

I won’t lie. We waited with bated breath for this announcement. Before this, the government broadcasted little on the COVID-19 impact on commercial property leases except for “sort it out amongst yourselves”.

Today’s post outlines:

1. 1. The purpose of the new commercial leasing principles during COVID-19

1. Highlights of the COVID-19 Commercial Leasing Code of Conduct
2. Leasing Principles – The new rules of leasing negotiations
3. Winners from the Code of Conduct
4. How tenants and landlords can create a win-win outcome

There will be more details to come when this Code becomes law. But here’s what we know so far.

COVID-19 Commercial Leasing Code of Conduct

For reasonable and understanding landlords, the COVID-19 Commercial Leasing Code of Conduct was in line with the existing approach: Help tenants survive COVID-19 and we’ll all still have a business after the pandemic.

At Properties & Pathways, this has been our approach since our first discussion with tenants when the crisis began. It’s now mandatory for every other Australian commercial property landlord.

Purpose of the new commercial leasing principles during COVID-19

The Code of Conduct helps tenants who have been severely impacted by COVID-19, and ultimately aids their cashflow.

The aim of the Code is to balance the interests of landlords and tenants, and it also acts a guide to good faith negotiations between both parties while COVID-19 impacts commercial property leases.

The Code only applies to SME tenants (i.e. turnover lower than $50 million) and it doesn’t apply to lenders.

Highlights of the COVID-19 Commercial Leasing Code of Conduct

Here are a few of what the government calls the “overarching principles” of the Code:

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Landlords and tenants share a common interest in working together, to ensure business continuity, and to facilitate the resumption of normal trading activities at the end of the COVID-19 pandemic during a reasonable recovery period. The Parties will take into account the fact that the risk of default on commercial leases is ultimately (and already) borne by the landlord.All leases must be dealt with on a case-by-case basis, considering factors such as whether the SME tenant has suffered financial hardship due to the COVID-19 pandemic; whether the tenant’s lease has expired or is soon to expire; and whether the tenant is in administration or receivership.

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Landlords will feel the brunt of the sword. It’s assumed by the federal government that landlords have the means to survive this lockdown, while tenants – we can safely expect, mostly retail property tenants – need a leg up until business resumes in some form of normality.

But, as the government says, all must be dealt with on a case-by-case basis.

Leasing Principles – The new rules of leasing negotiations

These are the rules that both tenants and landlords must play by.

(We’ve added our own commentary around each.)

1. Landlords cannot terminate the lease if rent is unpaid during the COVID-19 pandemic period. The “COVID-19 pandemic period” is not defined in the Code. But we can safely assume this will be until at least October.
2. If the tenant can’t abide by conditions of the lease, they’ll forfeit any protections provided under the Code. Tenants don’t have to pay rent (for now), but they still need to respect the conditions of the lease.
3. Landlords must offer rental waivers and deferrals for 100 per cent of the ordinary amount payable.
4. Rental waivers can be no less than 50 per cent of the total reduction in rent payable over the COVID-19 period.
5. Payment of rental deferrals by the tenant must be amortised over the balance of the balance of the lease term (of no less than 24 months). So, if there are three years remaining on the lease. The rental deferral must be paid back within the first two years.
6. Landlords should waive recovery of any other expense by a tenant during the period the tenant is unable to trade. But Landlords can reduce services as they need. This is crucial for landlords’ survival as well.
7. Payments should be made over an extended period in order to avoid placing financial burden on the tenant.
8. No fees or interest can be charged on any rental deferrals.
9. Landlords must not draw on a tenant’s security for rent not paid during the COVID-19 period and the “recovery period”.
10. The tenant has the ability to extend its lease for an equivalent period of the rent waiver or deferral period. This gives the tenant time to trade in the recovery period.
11. Rent increases are not allowed for the duration of the COVID-19 period and the recovery period.

Who’s better off as a result of the new code of conduct? Landlords or tenants?

Landlords are being asked to take a hit for the greater good.

The COVID-19 Commercial Leasing Code of Conduct states they’ll need to waive a portion of rent set out in the lease agreement – without any rent relief from the bank or subsidy from the government.

The only bank relief available for commercial landlords is a deferral of mortgage interest repayments. This interest won’t need to be paid until after 6 months’ time, but it will accrue and go on top of the existing loan amount (called interest capitalisation).

Meanwhile, tenants are allowed to reduce rent in line with their revenue losses.

There is also a provision in the Code to ensure tenants give proof of their financial hardship. This should stop any opportunistic debt relief requests around the country.

Working with commercial tenants will mean a win-win outcome

For both commercial property tenants and landlords to find order in the chaos, both parties will need to communicate. The lease agreement must still be respected, but so too should a partnership between property owners and their occupants.

Savage landlords will be left on the wrong side of history should they fail to support their tenants. It is a time to collaborate and work for the greater good. After all, no one wants to end up on a deserted island as the last chapter of COVID-19 unfolds.

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