Abolish upward-only leases now

There have been an unprecedented number of vacant properties on the capital’s main shopping streets in the past few years due to unsustainable rents caused by the upward only rent clause in leases
There have been an unprecedented number of vacant properties on the capital’s main shopping streets in the past few years due to unsustainable rents caused by the upward only rent clause in leases

Maintaining upward only rent agreements is only serving the interests of the property developers, and the government’s reluctance to abolish these outdated laws is simply bogus, writes Dan White



22 July 2011

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With Xtra-vision having become the latest major Irish retailer to seek protection from its creditors, mainly landlords, it is clear that the government must face down the property lobby and abolish existing upward-only leases.

Over the past two years a veritable who’s who of major Irish retailers have been forced to seek protection from their creditors. In most cases the main creditors are landlords who seem to think that it’s still 2007 and refuse to cut their rents. Indeed there are still a few deluded landlords out there who are seeking rent increases under the terms of upward-only leases.

Constitutional difficulties

After much prodding and no little bad grace, the previous government eventually banned upward-only leases in March 2010. Unfortunately, citing the standard excuse for governmental sloth and indolence, “constitutional difficulties”, it left existing upward-only leases untouched.

Since no-one in their right minds had entered into an upward-only lease since at least 2007, the banning of new upward-only leases was an empty gesture. Meanwhile, trapped in existing upward-only leases a slew of major Irish retailers including O’Brien’s Irish Sandwich Bars, Golden Discs, Hughes & Hughes and most recently Xtra-vision have been forced to seek protection from their creditors. In virtually all of these cases the main problem was recalcitrant landlords with upward-only leases refusing to budge on the rent.

As things stand it is only by pressing the nuclear button and going into receivership or examinership that an Irish retailer can extricate themselves from unaffordable upward-only leases. That’s no way to run a railroad, let alone an economy.

Supply and demand

Making matters even worse is the fact that, even during the boom, the arbitration mechanism for setting retail rents was seriously flawed with retail rents increasing by an average of 240% between 2000 and 2007 as against an increase in the consumer price index of just 30% over the same period. To add insult to injury the supply of retail space was increasing rapidly throughout this period with available shopping centre selling space quadrupling and retail park space growing more than ten-fold. Quite clearly, even during the boom, the laws of supply and demand were not working in the retail property market.

Since the bubble burst in 2007 an already bad situation has become even worse. With the value of non-motor retail having fallen by over a sixth since 2007, Dublin retailers are now paying an average of almost 15% of their sales in rent, getting on for twice the European average. Meanwhile, as the latest Eurostat figures show, the price gap between Ireland and the rest of Europe is rapidly narrowing as domestic deflation takes hold.

According to Eurostat, average Irish prices were 18% higher than the EU average in 2010. While this is still far too wide a gap it is down from 27% in 2008. When the next set of price comparisons are published they are likely to show a further narrowing of the price gap as the impact of Ireland’s “internal devaluation” makes itself felt.

However, Irish prices need to fall even further if we are to close the gap with the rest of Europe. With Irish retailers paying an extra 7-8% of their turnover on rent than most of their European counterparts, reducing retail rents is an essential precondition of further narrowing the Irish price gap with Europe. That can only be achieved by scrapping upward-only leases.

Double referenda?

First things first. The government’s decision to have a referendum on such a relatively trivial issue as judges’ pay exposes the “constitutional difficulties” argument as bogus. It always was. If the government is prepared to go to the people to reduce our learned friends’ pay packets then it can surely do the same with upward-only leases. In fact, why not hold both referenda on the same day and save ourselves a few bob?

No, the real reason why the government has been dragging its feet on abolishing upward-only leases has been the furious lobbying of the property sector, which of course now includes that state-owned bureaucratic monster otherwise known as NAMA.

The views of the property sector were best articulated in a recent report by economic consultants DKM, which calculated that the abolition of upward-only reviews would knock €14bn off the value of Irish commercial property. The report, which was commissioned by the Irish Association of Investment Managers, claimed that the state would have to pump a further €5bn into the banks and pay €1.8bn of compensation to landlords.

It then went on to argue that claims abolishing upward-only leases would save 30,000 jobs were “implausible” and that 20,000 jobs would be created by such a move were “highly implausible”. According to DKM, jobs in the retail sector “would not be revived solely by a change in terms of lease agreements”.

One pays one’s money and gets the answer one wants.

A jobs hemorrhage

However, what is indisputable is that 40,000 jobs have already been lost in the retail sector. With retail sales down by more than a sixth, and Irish retail rents almost twice the European average, the jobs hemorrhage shows no signs of stopping any time soon.

And as for the notion that commercial property values would fall by €14bn if upward-only leases were abolished, wake up and smell the coffee lads. No investor in his right mind is going to value Irish property on the basis of rents received under upward-only leases. Everyone outside the bubble that is the Irish property sector has long since concluded that upward-only leases aren’t long for this world and adjusted their valuations accordingly.

Rewrite the rules

The compensation argument is similarly suspect. By introducing a constitutional amendment the government can effectively rewrite the rules and it could also argue that the market had already discounted the likely abolition of upward-only leases. And as for pumping even more money into the banks, they are already so bust that abolishing existing upward-only leases is neither here nor there.

The arguments in favour of abolishing existing upward-only leases are compelling while the arguments against are largely spurious. Justice Minister Alan Shatter should turn a deaf ear to the pleadings of the property sector and abolish existing upward-only leases as quickly as possible.



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