“What is unnatural will not endure”
German Chancellor Konrad Adenauer in 1963 at the sight of the Berlin Wall
This new government is getting off to a disappointingly slow start. Even though it is a coalition of centre-right and centre-left politics, the election manifestoes were surprisingly similar and the Programme for Government can’t have been too difficult to hammer out. But amidst the U-turns, hidden qualifications, and general procrastination, we heard from RTE on Friday last, that new Minister for Justice, Equality and Defence, Alan Shatter is to refer the issue of implementing upward-downward reviews in upward-only leases to the Attorney General, Maire Whelan to consider the compatibility of any change to legislation, with our constitution. This hasn’t happened yet mind, it is something that the Minister is to do in the future.
The issue in a nutshell is that Ireland & the UK are the only countries in the EU where commercial leases have traditionally provided for upward-only changes to rent levels. We have had a major economic shock but many leases still demand tenants to pay rents in excess of current market rates. Some commercial tenants are struggling. Should the government allow the rent in these leases to be reviewed and to put in place a current market rent, then landlords, investors, pension funds, banks, NAMA and others will see the value of their assets drop significantly. On the other hand, some businesses that would otherwise fail will survive. Also a factor of production, property, will be priced at current levels. The government intervening in private contracts is seen as a major intrusion that may also be unconstitutional and may deter investors in property generally.
Thus far, this blog has taken a neutral stance on the issue. The change would bring about winners and losers. There will be more winners in terms of headcount – a landlord may only employ a couple of people but a retailer might employ 500 – and the cynic might say this was the reason that politicians offered this change during the election. But how will the economic gains and losses tally if the change is made? Difficult to say – on the one hand you will have a more competitively-priced factor of production without an historical distortion disproportionately benefiting one group. On the other hand, you will see owners of the factor of production, and related supports, facing actual losses in wealth and the general discouragement of investment (domestic and foreign) in a jurisdiction which intervenes in private contracts. The neutral stance on here has changed however, and now leans more towards the implementation of the election pledge contained in the Programme for Government.
The main reason for the change of heart is the appreciation that property as a factor of production is vital to our economy and should be priced at a competitive level determined by the market. Current market rents are more than 50% off peak and have been dropping at 20%+ per annum annualized in each of the last four quarters’ indices from Jones Lang LaSalle. To distort the market through historical agreements is anti-competitive . All other jurisdictions in the EU, except the UK, allow upward-downward reviews of commercial rent which follow local economic conditions. In terms of the EU, upward-downward reviews are the standard – Ireland and the UK stand alone as idiosyncrasies. I feel that I should produce more detail in support of this position, but allowing markets to operate freely is an ideology and to a large extent, you accept that ideology or you don’t.
Of course, our freely- operating market had given rise to upward-only review leases in the first place and these leases were entered into voluntarily by both tenant and landlord. Arguments that the government should never have allowed such agreements are moot and in the coulda-shoulda-woulda category because the fact is that we have lawful contracts today which maintain rents above current market rates. So what can the government do to deliver its Programme for Government commitment?
(1) Legislative changes. This seems to be the preferred route and is presumably why the Minister is to refer the matter to the AG. There may be constitutional issues with the government intruding upon private contracts but I think this has been overblown. Other countries, including the UK, have successfully made changes to property related contracts, eg residential leases which have faced immense resistance but have been upheld at a European level. Also we have had legal changes here in recent years which have diluted rights of landlords, for example the precedent established in 2009 that companies in examinership can repudiate leases.
(2) Taxation changes. If the legislative route is seen to be too difficult then the government can deliver its commitment through changes to the tax system. Take the scenario illustrated above. The rent specified in the upward-only lease is €100 per sq foot per annum. The current market rent is €45 psf. A change to the tax system might see the difference between the current market rent and the lease-determined rent, €55, taxed at 100% and a tax allowance of the same given to the tenant. This is Proposal A. There is a second proposal, Proposal B which would further penalize the landlord by taxing him at 100% of the difference PLUS 10% and would not pass all the benefit to the tenant by only giving him 90% relief on the €55 difference. This would be to pay for the cost of administering this tax system and also to encourage landlord and tenant to agree a market rent.
How might the government address the downsides to any changes
(1) Compensation for landlords. Landlords and their associated supports, eg banks and property agents, are being disadvantaged because contracts agreed on an open market basis are being intruded upon and changed in a way which will reduce the value of the landlord’s asset. All to assist the economy and ensure we are a competitive country. So might there be some way in which this mandated sacrifice might be compensated? I think there is, but it won’t unfortunately be an upfront lump-sum because the State can’t afford that. But on an ongoing basis, the State can act to reduce certain taxes or levies which would provide landlords with a share of the increased national wealth generated by having a more competitive factor of production. It was interesting to hear yesterday that NAMA apparently lobbied the Department of Finance in May 2010 on this issue. I wonder how such an approach today would be viewed through the prism of the NAMA Code of Practice on the conduct of NAMA officers which forbids lobbying of the sort set out under section 221 of the NAMA Act – on a strict reading of the Act, NAMA would probably be okay but would this sort of lobbying be contrary to the spirit of the Act?
(2) Deterring investors. Imagine that you are investing in a foreign country, a country that you assess as stable and which upholds the rule of law and allows you to generate a return on your investment. All of a sudden that country decides to appropriate your asset and not pay you for it. How likely are you to invest in that country again? Well the experience of countries where this has happened tells us that investors will come back but they will be more cautious than before. But what Ireland is proposing to do is to bring its commercial leases in line with the rest of Europe and ensure that a major factor of production is priced at a competitive level. Even if this government yellows it on this commitment, then investors will still have somewhere in their minds that the next government, which might be more left-wing by the way, will introduce the change.
To bring us back to Konrad Adenauer’s philosophy on the Berlin Wall, upward-only review leases are unnatural and will eventually fall because the natural dynamics of competition will prevail. It is to be hoped that the government addresses the issue sooner rather than later – procrastination helps no-one.
UPDATE: 5th April, 2011. On the RTE Frontline programme last night the new Minister for Justice Equality and Defence Alan Shatter appeared on a panel to discuss this subject. The upshot is that legislation to allow downward reviews in Upward Only Rent Reviews (UORRs) will be presented to the Dail before the summer recess, or shortly afterwards and will be enacted “before the end of this year”. It is unclear if the legislation will be backdated, that is there may be a refund due to the tenant for historical rents and it is also unclear how market rents will be determined – the eligibility for using the new legislation and the arbitration process for examples – but it seemed clear from last night’s programme that tenants felt the present arbitration process was biased towards landlords.
UPDATE: 6th April, 2011. If a reminder was needed, today in the Irish Times the negative impact of the proposed legislative changes is detailed with respect to the pensions industry where the Irish Property Unit Trust (IPUT) describes the effect of the proposed change on its prospects. IPUT is the largest property unit trust in Ireland, founded in 1967 and having some €427m in assets under management. It is reportedly the second largest property fund in Ireland after Irish Life. It acts on behalf of investors, pensioners, charities. It repeats the credible claim that property values will drop by some 20% on average (that’s for an average basket of UORR and non-UORR properties, apparently and based on research undertaken by IPD on behalf of the SCS). IPUT says that it may challenge the constitutionality of any legislation in the Supreme Court. IPUT also claim that a large proportion of retail tenants that have sought relief from UORRs has been accommodated by landlords. On a separate matter, IPUT’s outlook for rents is not so good with a prediction that it will be 2012 before there is any upturn and then possibly only in Dublin 2.
UPDATE: 7th April, 2011. And on the other hand …. Retail Excellence Ireland is certainly ramping up its campaign to have legislative changes made to UORRs enacted, with claims that employment will be protected and expanded if the expected changes are implemented, though there seems to be an additional hook that reductions in business rates might also be needed. There’s a press release here and re-publication of a letter to the Irish Times here.
UPDATE: 8th August, 2011. The Sunday Business Post reports on a meeting between justice minister Alan Shatter and commercial tenants from Grafton Street in Dublin. The report suggests that the legislation will be introduced in the autumn but that there are difficult Constitution-related obstacles to be overcome. Again the term “exceptional circumstances” has cropped up in the context of tenants seeking rent reductions, suggesting that tenants will face obstacles in seeking reductions.
UPDATE: 5th September, 2011. I am beginning to see why Brendan Burgess has banned discussion of house prices on the askaboutmoney.com website, after a discussion attracted 8,000 posts which were said to have generated more “heat than light”. The UORR debate is in danger of going the same way on here, though thankfully it looks as if there will at least be some clarity on the contents of the new bill in the next couple of weeks. This text is being shown as an update to deliberately avoid an avalanche of mostly perseverated comments, though there will be a full entry once the heads of the new bill are published. Today the Irish Times carries an editorial-type 1,500-word article by its economics correspondent, Pat McArdle which must be one of the most shameful contributions ever to Ireland’s “paper of record”. Far from an independent review of the issues, it contains error and bias on a scale which you might expect to see from a representative of one of the vested interest groups whose interests will be affected by the imminent changes. Even the title of the piece “Changing rent reviews will have serious consequences” heralds bias – “serious consequences” could theoretically be positive or negative but you rarely hear that winning the lottery would carry “serious consequences”. The article opens with a call for a debate on the subject. What does Pat think has been taking place for the past couple of years? Is he not familiar with our legislative process whereby a bill is presented to the Oireachtas and debated in both chambers and at committee? And no doubt the contents of the bill will be thoroughly aired in our media. No, what Pat seemingly wants is for the legislative process to stop proceeding along its assumed path and scale down the changes. Pat claims that there would be “a further 20 per cent decline in prospect if UORRs are banned.” We have heard this 20% from different sources, most notably IPD and I think IPD’s projections are respected but IPD made its projections before the start of 2011 and already this year commercial property prices have dropped by 7% and industry sources confirm that some element of the drop is attributable to imminent changes in legislation on UORRs. So if IPD were asked to re-calculate their estimates today, it is likely they would be estimating 10-20%. Now 10% is still a major decline but let’s keep in mind the decline will be less than 20%. Pat claims “the stress tests have allowed for extra falls in commercial property prices, any generalised scheme could quickly erode existing capital buffers in the banks to the ultimate detriment of taxpayers” – indeed the banks have been stress tested for the abolition of UORRs and that is why the adverse case decline in 2011 was 22.5% whereas the baseline was a 2.5% decline. Of course any loss to state-owned banks is to be regretted but the banks have been capitalized with the abolition of UORRs in mind. Pat cites a study in Wicklow town carried out by CBRE and funded by property companies in which it was found that very few retail tenants had sought rent reviews and been turned down; Pat claims that only 2% of the total units were refused yet this claim is at odds with Pat’s position on serious consequences of the imminent changes – after all, if only 2% of units will be affected then will the consequences really be that serious? Pat throws up a few graphs but puzzlingly he shows a graph of transactions rather than values and concludes on the basis of transactions that UORRs have blighted the market. If he were to examine prices he would see the market in 2011 is pretty flat with 2010, no change one way or the other. There are several references in the article to the Colm McCarthy report which Retail Excellence Ireland (mostly represents retail tenants) commissioned. REI has declined to formally provide me with a copy though I have read the report. Colm tends to be respected by most sides of most debates and when he suggests rents account for around 15% of a retailers turnover that claim generally commands respect though Pat in this article says that “industry sources put it at 3 to 7 per cent”
UPDATE: 6th September, 2011. The Irish Independent today carries an article by Roisin Burke, a journalist at the Sunday Independent Business Desk which cites sources and insiders. Notwithstanding the credibility of said sources, the article does carry detailed claims, that the bill will be introduced in “October/late November” and whilst in line with Aine Coffey’s article in the Sunday Times in July 2011 there is an important new claim – “A lease would be judged on a standalone basis. “For example, if you have 12 shops across Ireland and 10 of them are doing quite well, but say two of them are crucifying you because of off-the-wall rent, you should be able to get a review on the basis of those two individual stores and not on the basis of your overall balance sheet,” the insider said.”. If true, conceivably this could mean a retailer with vast disposable means might be able to secure a revision to his lease, as long as the enterprise subject to the lease was confronting with at present unquantified financial distress.
NAMA Wine Lake 
On legislative changes, I would have thought that Section 2 of Article 43 of the Constitution dealing with private property would cover any constitutional issues. It states:
“The State recognises, however, that the exercise of the rights mentioned in the foregoing provisions of this Article ought, in civil society, to be regulated by the principles of social justice.
The State, accordingly, may as occasion requires delimit by law the exercise of the said rights with a view to reconciling their exercise with the exigencies of the common good.”
So the tax payer is saddled with NAMA, a gravy train for those that caused this boom to bust in the first place and now want to sit back as they draw down huge ‘safe’ salaries from the sale of distressed assets, Ireland’s liquidators. Taxpayers are supposed to stand by as NAMA SPV seeks to keep rents at completely unsustainable levels despite the country heading towards default. The tax payers must pay for NAMA, bondholders, stealth taxes and must even make the ultimate sacrifice and join the dole queues to protect property investors, pension funds and zombie banks (soon to become pillars) which they have already pumped 72bn into? This problem has been around since the beginning of the crisis and yet it is being given another mighty kick down the road.
We will be told that we cannot interfere with existing contracts by the attorney general because if he said anything else then his own pension could be interfered with, Bertie and Brian Cowen’s pensions could be altered. Government workers who have been milking the system do not want the principle of “contracts” being changed even if they were based on a myriad of false premises, malfeasance or sweetheart deals because that modus operandi has been the ‘bed rock’ of how this state has operated and ultimately failed.
NAMA was supposed to act for the benefit of the tax payer it does no such thing, by straining every nerve and sinew to try and prop up completely unsustainable commercial rents that are based on the fallacious and ultimately suicidal logic of the celtic tiger.
Rogoff and Reinhart chronicled over 700 years of booms and busts but strangely none of the legal or political elite quango’s knew any of that when they allowed these discriminatory upward only rent reviews. Despite us heading relentlessly towards default Ireland, NAMA, the government seem to think it is still in our interest to put even more Irish people on the dole. The for sale signs are hanging over the NAMA SPV distressed assets, and it is an inconvenient truth for NAMA that unemployment is heading officially for 16% and the country is insolvent. This is not a recipe for growth but rather the same jaded thinking that has has reduced us to the begging bowl and “kindness of strangers”. NAMA wants to circle the wagons and ordinary Joe can lick his wounds.
Did you see my piece in IT Saturday on Nama’s view of issue
Indeed Neil, it’s referred to above & WSTT kindly drew attention to it in a comment yesterday. NAMA’s letter was written in May 2010, a couple of months before its Code of Practice on lobbying came into effect, I wonder would NAMA be able to lobby in the same way today? But yes, the calculation is that an average portfolio of commercial properties in Ireland would drop by about 20% if upward-only leases were made upward-downward.
@NWL. There are a couple of issues here that should be noted.
For the past 55 years, tenants in commercial properties have been paying less than the market value of the rent 80% of the time (often substantially less) as the rents only get marked to market every 5 years. This is the first time in my lifetime where rental levels on long term existing leases have been been in excess of the market level – and that only for the last 3 years. I did not notice the landlords squealing like stuck pigs when the shoe was on the other foot. Should there be a reciprocal arrangement when the rent is lower to ensure fairness?
Similarly with your tax suggestion above. Should there be tax credits to the landlord when the rent does not reflect the full market level?
The big problem is not that there should be market level rent reviews under the new legislation, but that these are being imposed on all existing legally AGREED leases by use of retrospective legislation. It is the old sledgehammer / nut syndrome to deal with a small number of retailers who are suffering a loss of business because of the recession. Most of these can be solved by negotiation (the majority of landlords are not turkeys that want to vote for Christmas). The rest will be solved by competition in the market place – Darwin’s law of the survival of the fittest. And in a capitalist economy, that is how it should be.
Who will invest in a country where there is no certainty in civil and contract law?
An added twist to this proposal which has huge legal issues for the government is that they themselves are often a party to a lease as tenant. Legislating to give themselves a rent reduction contrary to their own signed contracts? – A legal minefield, I would have thought.
@WSTT, very fair points if I may say. For a landlord to watch a tenant paying a rent set years ago when current market rents are racing away is indeed frustrating; but then to be walloped when the shoe is on the other foot, as you say, seems very unfair. Though of course, tenants might be able to last five years paying above market rates but if there is no prospect in the next 20 years of getting your rent to reflect the current market also doesn’t seem fair.
You say the problem affects “a small number of retailers” – Retail Excellence Ireland might claim it was widespread, but as the lovely Mandy Rice-Davies would have said “they would say that, wouldn’t they”. I don’t know the true extent of the problem and outside a commercial leases database it will be a matter of whose claim you believe.
A dilution of property rights is not to be undertaken lightly, it will have consequences and the government should look at ways in which compensation can be offered.
But if the problem is as significant as we are led to believe, then a responsible government must weigh the greater needs and the present perception generally, and in the government particularly, is that the greater need is on the side of commercial tenants.
Dear Member,
Please note that this update is confidential and not for circulation to any 3rd party under any circumstances.
REI has just learnt that the draft legislation to abolish upward only rent review provisions in leases with retrospective effect has commenced preparation. The legislation is being prepared in consultation with the Attorney General. It is anticipated that the legislation will be passed prior to the summer recess. We have not seen the Bill but are hopeful that it will contain provisions allowing all commercial tenants to trigger a review in 2011, thereby allowing all rents to be reviewed to market level. If it does not allow the triggering of an immediate review, the legislation will apply at time of next scheduled review. The Bill may not be published in the Government schedule of legislation if the heads of the Bill have not been defined in time for inclusion in the schedule. REI will seek a draft of the Bill as soon as it is made available.
Once enacted, there are three scenarios which might play out –
* Scenario 1 – The legislation is enacted and is not challenged.
* Scenario 2 – The legislation is referred to the Supreme Court by the President. This offers a positive and a negative. While needing Supreme Court approval, if passed by the Supreme Court, any provisions referred will thereafter be immune from further constitutional. The negative is that the legislation is not signed into power by the President until the Supreme Court passes same (this should be an expedient process).
* Scenario 3 – The legislation is enacted, signed by the President and becomes law with effect from the date designated for commencement. We hope that would be mid 2011. The legislation can be challenged in the Supreme Court by a 3rd party. The legislation continues to apply unless the Court deems it unconstitutional.
REI is cognisant of the need to push for greater transparency at time of rent review, thus having achieved a market rent through legislative intervention; the rent can only increase in line with real market evidence.
We will keep you informed of developments as they become available to REI.
Yours sincerely,
David
David Fitzsimons
Chief Executive Officer
Retail Excellence Ireland
T: 00 353 65 6846927
F: 00 353 65 6892451
W: retailexcellence.ie
If retailers want to get out of leases they can go examinership route. They just don’t want bad publicity
The idea that legacy leases were “negotiated” is a complete fallacy. In late 1998 we were offered an ‘industry standard’ lease of which no clause was negotiated. Upward only rent reviews every 5 years, full repairing and insuring, no break clause, restrictive sub-letting conditions – all standard take it or leave it. Because we are a small independent retailer with ‘no convenant’ we were also required to sign personal guarantees. Examinership does not protect a tenant if a personal guarantee is signed even if the lease is repudiated. Our situation is not unique.
I think many retailers like us who signed up in the late 90’s could never have foreseen the boom that led to huge property and rent inflation. Nor could we have predicted the biggest percentage fall in retail sales since the 1940’s.
The disparaging of tenants as being in some way flawed businesses that don’t have the smarts to survive this turmoil is just adding insult on top of the injury of carrying an overhead that can never be reduced.
For over a year now these clauses have been declared illegal in new leases. This has the dual effect of giving competitive advantage to new leaseholders and making legacy leases virtually non-transferable and shutting down mobility in the marketplace so even a strong business which needs to relocate for more space etc cannot do so without paying a huge penalty to the landlord or a substantial incentive to the new tenant.
On another property blog, in an exchange between two supporters of retaining UORR, it was calculated that a loss of 10% of retail jobs (24,000) was a price worth paying to maintain the status quo.
It is time for some kind of reality to prevail. Call it the concern for the greater good or allowing a true market to emerge. Allow for annual reviews so no one ends up over or underpaying. I don’t really care how it is framed as long as I and many other businesses can gain control over the biggest cost of doing business in Ireland. Soon.
The greater good?
Which is the greater good? The investments of pensioners in pension funds, the holders of insurance policies, the taxpayer holding investment property through NAMA or a retailer?
Just asking the question.
I meant to say ‘the common good’ as referenced by Brian Flanagan in the first comment quoting the Constitution.
The common good takes account of all citizens. Retailers are for the most part pension investors and are all undoubtedly taxpayers too. Why try to make out that we all exist in isolation when we don’t or to pitch people against each other when we are all essentially in the same predicament having got here by different paths? It’s easy to trot out the same well rehearsed arguments we’ve seen in the press rather than face reality.
Keeping UORRs to prop up property values in or outside NAMA or pensions is flawed – it’s just another example of deferring the inevitable value re-alignment that will happen as leases come to an end. Then – as happened with the Burger King lease on Grafton St – the rent will drop right back to what would be the market value if there was an actual market in commercial property as opposed to fixed situation that pertains now.
Better to get all of the pain out in the open now and take the bitter pills. Once we all know the true scale of every loss of value – commercial property included – reparations can really begin.
PS About 3% of pension values are affected by commercial property values. Any fund manager who is caught for more just took a bad punt. “The value of investments may go up as well s down….”
Hi PGD,
you’d be a fan of ‘mark to market’ then? which of course begs the Q “where’s the market?”
there’s some pretty good analysis of legacy leases in this SBP article by Tom Dunne… (oops can’t seem to fine a link for the article in the SBP on the 27th/3/11 in P7 of the property section, commercial).
One of the main points in the article is ‘secrecy around property transactions’. NWL has been banging the drum for a transparent property sales transaction database for some time and should continue to do so. Please.
@JR, with respect to the House Price Database (HPD) and the commercial rents database, I temporarily put my drumsticks away in February 2011 when the general election was called. The present status of both databases is that there is a draft amendment to the Property Services (Regulation) Bill which was produced by the last government just before it dissolved, FG has indicated that it will pick up this Bill amendment and progress it. There has not been a mig out of the new Department of the Environment Heritage and Local Government minister Phil Hogan or indeed justice minister Shatter. Both Labour and FG harried former housing minister Michael Finneran last year for the HPD so I hope that there will be progress in the matter soon.
There is a specially devoted page for the HPD which captures all the latest developments here
https://namawinelake.wordpress.com/about/house-price-database/
Creditors Volentary Arrangements have been used many times in the UK by tenants to rework leases. JJB has now done it twice. JJB, the second time around, offered some upside to their landlords if the business recovers.
Surely this is a far better process than changing property rights.
Plus you won’t see any development based of the back of downward rent reviews. You can’t secure the investment.
In europe mose leases are indexed to some form of CPI, so are not really likely to fall by much.
Landlords know full well that sticking to over-rented leases can be voting for christmas. Another thing that works well in the UK is making landlords liable for 100% of the business rates once a tenant vacates.
On the other hand, if you have a poor tenant in a space and you know that you can get a better tenant in, then you should be able to do so. This is very important, it’s good for both the landlord and the widder economy. Many retail business are great, but some are really not worth saving. Look at Woolworths in the UK, many of their sites were taken by Waitrose, and 99p stores, both of whom are great operators, and will actually probably create more empolyment from Woolies did. So a net gain to the economy.
Oh and the billions of infrastucture investment that is needed – no chance – it’s all based on long term contracts. Look how in the UK the government will not change PFI contracts, despite some of the early ones being very bad value for money. And when you do secure infra investment the cost of 100 or 200bps risk premium for 20 years is massive.
[…] you’d be hard-pressed to find a better example than the farce that has surrounded the issue of Upward Only Rent Reviews (UORR) in commercial leases; remember both Labour and Fine Gael had promised to abolish UORR terms […]