OPINION:Important facts have been lost sight of in the upwards/downwards rents review debate, writes ANN HARGADEN

THE PRE-ELECTION announcement of proposals to carry out “upwards/downwards” rent reviews on all Irish commercial property leases in 2011 has compelled numerous lobbyists to push their respective agendas on the public.

This has unfortunately led to a great deal of misinformation (or, at the very least, many ill-conceived arguments) being presented through the media. The following are some simple facts that need to be highlighted and, more importantly, understood by all concerned.

1 INTERDEPENDENCY

A commercial landlord’s role is to provide the funds necessary for a tenant to be able to occupy a building without having to first commit the capital required to construct that building, e.g. an office block. This enables willing tenants to pay a fraction of that capital requirement per annum (i.e. rent) over an extended period of time and use their additional funds to finance the operation of their business.

In order to finance the initial capital requirement of the premises most landlords borrow from banks, agreeing to repay the banks a proportion of the loan per annum together with the agreed interest rate, which is funded by the rent.

The bank insists on certain conditions being met throughout the term of the loan, such as loan-to-value obligations whereby the value of the outstanding loan cannot be greater than (say) 75 per cent of the property value at any given time. If the loan-to-value obligation is not maintained the bank will demand additional capital from the landlord or take ownership of the building.

In short, the landlord, the tenant and the bank enter into a legally binding commitment to meet their side of the transaction.

Each party receives prior independent legal advice (i.e. they appreciate what they are committing to) and it is clearly understood that the various terms cannot be altered by any of the contractual parties without the agreement of the others, e.g. the bank cannot arbitrarily increase interest rates, the landlord cannot arbitrarily increase rents and the tenant cannot arbitrarily reduce rents as all such matters are clearly provided for in the respective agreements.

Accordingly, if the bank, the landlord or the tenant are in difficulty as regards meeting their commitments at any given stage they are no less accountable than any of the other parties to the transaction. So, can it be equitable for the government to intervene and retrospectively change the terms of an existing lease so that one party is assisted to the detriment of the others?

2 THE MULTIPLIER EFFECT

It is not widely appreciated that a relatively modest reduction in rent has a significantly larger impact on the capital (as opposed to the debt) invested in the property due to property values being determined by a multiplier of the rent and the investment yield. An example best illustrates this point: if a landlord purchases an occupied office building with a 10-year lease with an annual rent of €100,000 he is likely to have paid about €1.32 million (based on a 7 per cent yield). To finance this he is likely to have borrowed approx. €990,000 from the bank (i.e. 75 per cent of the €1.32m) and paid €330,000 himself. If the rent were to be arbitrarily reduced by 30 per cent to €70,000 per annum, the value of the property would reduce to €925,000 resulting in the landlord losing €395,000 (or 100 per cent of his initial capital invested plus an additional 20 per cent).

So, to ask the question again based on the example above, would it be right for the government to legislate to arbitrarily save a tenant 30 per cent of their rent at the cost of 120 per cent of the landlord’s capital?

3 WHO REALLY PAYS?

We have been hearing much about “faceless” pension-related institutions who are landlords. Ignoring the fact that these institutions are actually managing the savings of Irish citizens (amongst others) and the fact that they have an obligation to act in the best interests of the people who have trusted them with their savings, the majority of landlords are individuals or companies endeavouring to earn a return on their available funds, similar to what tenants do with their businesses.

Accordingly, it will not be faceless entities that will suffer financial hardship from the proposed intervention by the government; it will be people from a broad spectrum of Irish society. This is not to mention the consequential financial stress to be suffered by the banks’ shareholders, which is now largely the Irish taxpayer. Let us also not forget that in many cases both the tenants and their employees are amongst those parties that will have their savings negatively impacted.

4 GOOD/BAD BUSINESS

We have also heard much about many landlords ignoring their tenants’ distress and refusing to negotiate with them on rents. The idea that a landlord would willingly allow a tenant to become insolvent and leave himself with no income to meet his loan repayments is ludicrous. There is a distinct lack of demand for available commercial space in Ireland at the current time and if a tenant cannot pay their rent it is unlikely the landlord will find a replacement, certainly not in the short term and certainly not at any rental level above “open market” levels that the “upwards/downwards” review will dictate. Accordingly if a tenant is genuinely having difficulty meeting their rent obligations (i.e. the alternative is bankruptcy) the landlord has nothing to lose and everything to gain by working with them.

It is of course possible that a landlord’s lending institution will not or cannot permit such flexibility, possibly because the landlord is not in a position to meet the consequential additional funding requirements that will be demanded of him due to his loan-to-value obligations or, more likely, the reduced rent will not cover the required interest on the loan. If the proposed reviews are to be equitable surely we can also expect the government to introduce legislation facilitating the landlord not meeting his loan obligations to Anglo or AIB or Bank of Ireland? Is this what the Irish taxpayer really wants?

5 THE RIGHT SORT OF ACCOUNT

If rent accounts for 5-10 per cent of a given business’s turnover (as is typical in most sectors) then a 20 per cent increase in rent is equivalent to a 2-4 per cent increase in their overall cost base. Additionally, as rent reviews occur every five years most tenants will not have had a rent review at the very peak of the market and the vast majority will have had a lease break option since the downturn commenced or will have one over the next couple of years, thus allowing them to exit their lease if they no longer like the lease they entered into. Perhaps rents are not the primary cause of most companies’ problems, as many recent articles would have us believe.

If the government wants to address extreme cases surely they can provide assistance to those individual viable companies as opposed to taking a blanket approach to the entire property sector where the numbers are vast and the implications for the state are also vast.

Claims that the proposed blanket rent reviews will save the state (i.e. the Irish taxpayer) money due to the jobs it will save are simply not true. Apart from the huge costs that will be passed on to landlords and banks by the proposal, it needs to be understood that it is not a choice between existing businesses or nothing. If the government was to decide not to assist a particular troubled business in meeting their obligations and that business was to become insolvent another would take its place . . . that is the nature of the free capital market we operate in.

For example, if a given retail outlet were to close on Grafton Street due in part to their existing rents, are we really saying that another store would not take its place and hire a comparable number of people off a new lease?

There are many individuals and companies operating in the property businesses that were prudent throughout the last property cycle and Ireland needs them (and their employees) to help us work our way out of this economic turmoil. Causing these people and companies inequitable distress is not an intelligent (or acceptable) solution.

We also need urgent substantial inward investment to help us solve our existing property problems (which are already too big for us to handle by ourselves given the troubled state of our banking system) and the very mention of the rent review proposal has already caused many potential investors to seek opportunities elsewhere – see February 26th Financial Times article – not to mention the damage it does to our international reputation by suggesting that legal agreements cannot necessarily be relied upon in Ireland.

The Irish taxpayer simply cannot afford further ill-conceived impulsive reactions to complex commercial problems and the outcome of the recent election was a clear message from the people on matters such as this. A clear understanding of the issues at hand and the full implications of any given proposal are not merely a desirable aspiration but rather a critical necessity.

Ann Hargaden is head of investments and a director of Lisney and