Code of Practice for commercial property relationships during the COVID-19 pandemic

Code of Practice for commercial property relationships during the COVID-19 pandemic

  • Posted by admin
  • On July 8, 2020
  • Comments
  • 3 likes

The code of practice, advising on lease agreement management through Covid 19, has set out lease amendment options for landlords and tenants to get through the crisis. The options listed are nothing new to landlords, however are intended to provide tenants with more knowledge to navigate through negotiations with their landlord.

Our accounting view and comment is not exhaustive and is our general view.

(The BOLD text is copied directly from the government guidance)

“The below sets out options of new arrangements that could be agreed to by both parties. While we all want to see cooperation and parties working together, these options are intended as suggestions and parties are not obliged to adopt them. This is not intended as an exhaustive list and parties may wish to suggest and come to other arrangements not set out below. Parties should also not take any inference from the order in which they are listed:

A full or partial rent-free period for a set number of payment periods.

Accounting

Calculate the rent-free effect on the remainder of the lease and adjust income accordingly.

 Where you have existing rent frees, recalculate rental income for the remainder of the lease and adjust income.

 Loan compliance

As with all lease amendments, the requirements to changes under loan agreements and the effect on loan covenants and compliance needs to be assessed.

 Fees

Some clients pay professional service providers based on rents collected, these terms will need to be negotiated.

 The change in rent collection terms may well have a material effect on investment managers IRR performance calculations, effecting performance-based provisions.

 Valuation

As with all changes to lease terms, the fair value of an investment property may be affected.

 A deferral of the whole or part of the rent for one or more payment periods.

Accounting

 Deferrals will impact cashflow, however should have no overall impact on accounting income. There will therefore be no need to calculate any rent incentive adjustment.

 Where the landlord is unsure over the recoverability of the deferral, potentially a provision for doubtful debts will need to be raised.

 Where the payment terms of the deferral are greater than a year, the asset will be recorded as a non-current asset. There may be a requirement to fair value the receivable.

 Cashflow

There may be an impact on cashflow from a VAT and distribution, if applicable, perspective.

 Loan compliance, Fees and Valuation

See point a.

 The payment of the rents over shorter payment periods for a set time (e.g. monthly rather than quarterly) including provision for their payment in arrears.

Accounting

No immediate material effect other than changes to your deferred income calculations.

Loan compliance, Fees and Valuation

See point a.

Rental variations to reduce ongoing payments to a current market rate and/or to provide for all or part of the rent to be paid as a proportion of turnover of the site, incorporating any period during which the site was closed.

Accounting

Existing lease incentive receivables will need to be recalculated and adjusted.Turnover rent is accounted for as a contingent rent and therefore only recognised once calculated and effectively agreed. This will have an accounting effect on the timing of recording income.

Loan compliance, Fees and Valuation

See point a.

Landlords drawing from rent deposits on the understanding that the landlord will not then require that the deposits be ‘topped up’ by the tenant before it is realistic and reasonable to do so.

Accounting

No real effect other than accounting for the reduction in deposits held. Financial statements may need to include an increase in liquidity risk as a result of reductions in deposits held.

Reductions in rent, either in whole or part, across other units occupied by the tenant and owned by the landlord, as part of a negotiated agreement applying to a portfolio of units.

Accounting

Adjustments will need to be made in line with point a. per property.

 

 

We have not come across portfolio valuations for some time and these are generally no longer used. The effect on valuations per property will need to be calculated. There will be fluctuations in valuations with the effect on loan covenants closely monitored.

Landlords waiving contractual default interest on unpaid rents or rents paid in arrears to make payment plans more affordable.

Accounting

Generally, this effects cashflow and not accounting.

Any interest not paid will need to be written off.

Provisions for ending the solutions on a fixed date, or on reaching the trigger point of particular circumstances.

Accounting

Where the provisions in leases for guaranteed fixed uplifts are amended, the accounting adjustment for the lease will need to be adjusted.

Where leases are extended, consideration as to the extension terms needs to be assessed and accounted for accordingly.

Tenants and landlords agreeing to split the cost of the rent for the unoccupied period between them.

Accounting

This appears to be referring to a discount on the rent which will have the same effect as a rent free period.  The accounting effect is documented in point a.

Any of the above in return for other arrangements e.g. a reversionary lease on reasonable terms, the removal of a break right in favour of the tenant, or an extension of the lease.

Accounting

As discussed above, where there are changes to the terms of leases, the effect on the recognition of income needs to be considered along with other key risks including cashflow, valuation and loan covenants.

Service charge and insurance

The one topic not covered by the mainstream press has been collection rates of service charge. The guidance has been documented below however our accounting view is standard across all service charge terms.

 It is important that buildings continue to be insured and safely maintained so that they are ready to support the economy’s recovery after the COVID-19 crisis. Any service charge and insurance charge payable under the lease is not profit-making, and, unless otherwise agreed, needs to be paid in full. Recognising the impact this may have on tenants’ finances, in relation to service charges:

Service charge generally has no effect on the P&L of a landlord as the service charge costs are recovered from the tenant. Service charge income = service charge expenses

 Where there are vacancies and caps on service charge, the landlord will incur their share, if applicable, of service charge expenses.

 It is therefore key for accountants always assess the risk that tenants will not pay their service charge, as ultimately, the landlord will be responsible to unpaid service charge.   These will need to be expensed, resulting in a reduction of profit.

 Seles accountants always review service charge arrears to assess the likelihood of having to provide for irrecoverable service charge income.

 Reductions and adjustment to service charge expenses should not have any material effect on the accounts of our clients.

Guidance below

  1. These should be reduced accordingly where the lack of use of a property has lowered the service charge costs incurred.
  2. Conversely, it is acknowledged that in some cases there may be additional service costs required, e.g. in order to operate a building which complies with health and safety requirements in the context of COVID-19, or recommissioning where buildings are reopened.
  3. Landlords should ensure that service charge costs are reduced where practicable and consistent with providing best value for occupiers.
  4. Where possible, the frequency of tenant service charge payments should be spread over shorter periods.
  5. Where there is a known net reduction in overall service charge due to lack of use of a property (taking into account any additional COVID-19 related costs), this reduction should be passed on to tenants as soon as possible ahead of the end of year reconciliation in order to help with cash flow and business viability.
  6. Landlords should ensure that all management fees reflect the actual work carried out in managing the services and the service charge during the COVID-19 crisis.
  7. Any solution the parties reach in relation to service charge should take account of the RICS Professional Statement Service Charges in Commercial Property, 1st edition and of all RICS guidance in relation to service charges and COVID-19.

 Final comments

The advice provided by Government is nothing new to the industry. From an accounting perspective, understanding the effect on cashflow and income is key for all landlords.

Stakeholders, including lenders, will want to understand the effect of lease term changes on cashflow, valuation and returns.

Loan covenants including loan to value and forward interest cover rates will be under stress with changing lease terms and the potential for increased bankruptcies.

If you need any assistance with changes to lease terms and the effects on your portfolio or have any comment, please email me at ryan.seligmann@selesgroup.com

SELES THE COMPANY

Seles is an ICAEW firm specialising in UK property accounting and financial control. We work as business partners with our clients, not administrators, across all client functions, working closely in providing bespoke services.   We have experience in all real estate sectors and are passionate about property accounting and working closely with our clients. See www.selesgroup.com for more information or email ryan.seligmann@selesgroup.com to explore how we can work with you.

If you have any questions and would like to talk to us about our services, please contact us at for a call or ZOOM chat.

CONTACT  Email: ryan.seligmann@selesgroup.com

 

0 Comments