Cautious Investments Ltd Case Study

Cautious Investments Ltd Case Study

Cautious Investments Ltd (Landlord) have been trading for more than 40 years and own several ‘sub-standard’ small tertiary shopping parades usually located as the sole retail offering on large part private-part public housing schemes around England. Each parade typically comprises terraces of three storey properties built in the 1960s with ground floor retail and two upper floors of residential (either self-contained apartments or maisonettes).Whilst the investment returns have been generally healthy until 2018 (between 9 and 12%), Cautious Investments is becoming increasingly worried about the longer term sustainability of these returns giving rising voids, lowering of returns, improvement opportunities, diversification and other legislative impacts such as the reduction of the payload in slot machines in betting shops.

The investor, your client, wishes to seek your advice on several strategic real estate and operational asset/property management matters.

(a) Critically examine 5 – 6 key tenant covenants found in typical leases of tertiary retail property and develop an asset management strategy that gives the landlord a high level satisfaction to know that landlord returns can be sustained or improved going forward (in this regard you may wish to develop a scoring matrix which covers both quantitative and qualitative aspects) and that tenants will be engaged and encouraged to either renew their tenancies or new tenants can be secured with flexible leasing arrangements.
Suggested word count: 1,000 words 10 Module marks (10%)(b) Develop a strategic/operational model on how the landlord could deal with rent arrears, showing how this would work in practice depending on the amount of arrears and the length of time this has been developing (a flowchart model may assist your thinking and answer).

Cautious Investments Ltd Case Study

Tertiary property is usually the one in the outskirts of major towns. The lessees of this type of property are usually self-employed people who have difficulties in proving their incomes or the ones who had previous financial problems (Independent Chartered Surveyors 2017,p. 3). As such, tertiary lending can be a high-risk investment for companies such as Cautious Investments Limited. This is well illustrated by Cautious Investments company by complaining of decreased returns. The company can adopt various measures to increase the profits, but it should do so by observing the tenant covenants that govern the relationship between the tenant and the landlord. The discussion that follows involves examining the tenancy covenants for the tertiary retail property as well as the possible options for Cautious Investments to increase returns. The discussion will again advise Cautious Investments on the best asset management strategy, including management of the rent arrears.

Part A: Tenant Covenants

Cautious Investment tenancy agreement involves both residential and commercial tenancy covenants. The landlord has leased the property for both commercial and residential services. With the three floors,  the ground floor has been leased for retail services while the two upper floors are used as residential. In the real estate context, the tenancy convent must contain both the commercial and residential property lease agreement (Carr et al. 2010). However, as per the case study requirements, only key tenancy covenant for the tertiary retail property will be discussed.

Although tenant and landlord are free to agree on the terms of the lease as presented by Newin (2019 p. 89), certain statutory provisions guide the relationship between the tenant and the landlord. Using Cautious Investment case study, tenant covenants for tertiary retail property lease will comprise the following:

To Honor the Lease Term

The tenants are required by the law to honour the lease term, meaning they cannot prolong their occupation in the landlord’s property when the lease term has expired without prior agreement (Designing Buildings Ltd., 2018). Lease terms vary with the statute allowing both long-term and short-term. For the tertiary retail property, a short-term lease is the most appropriate and ranges between 10 to 15 years. If the tertiary retail tenant has entered into an occupational lease with the tenant, they have the right to determine the lease before the end of the term (Newin 2019, p. 89). As such, the retail tenants of Cautious Investments can terminate the lease contract before it matures. The tenant can also request for a new lease, but the landlord can resist the grant based on the provisions of the Landlord and Tenant Act 1954[1] or any other applicable legislation. In Go West V Spigarolo [2003] QB 1140[2], the court using the Landlord and Tenant Act of 1988[3] ruled in favour of tenant because the landlord had no reasonable justifications for denying the tenant lease assignation.

Not Sublet or Assign

The tenants might be encouraged to sublease or change control of the tertiary retail property (Designing Buildings Ltd. 2018). The landlord might restrict the tenant from doing so since they want to make sure the new tenancy will be responsible for meeting rent obligations (Newin 2019).  In a typical tertiary retail occupational lease, however, the landlord cannot unreasonably withhold the consent for the tenant to change control or share occupation. The Covenant Act of 1995[4] provides landlords and tenants with the reasonable grounds upon which the assignation or subleasing can be accorded or refused. When the Landlords do not consent on time, and as a result, the tenant incurs a loss, the tenant can sue for damages as it was the case in Blockbuster Entertainment v Barnsdale [2003] EWHC 2912[5].

To Pay Rent

The tenant is obliged to pay rent periodically for the occupation of the building based on the agreement with the landlord (Maass 2017). The rent to be paid should be agreed upon before the tenancy period starts (Carr et al. 2010). The Landlord, like Cautious Investments, might be tempted to increase rent to cushion against declining returns. The law allows the landlord to review rent periodically. The regulation is meant to have a minimum return that does fall below the initial for the rest of the lease term even when the market prices have dropped (Newin 2019). The rent increase in the real estate industry is fixed is not determined by the market forces. The rent review regulations do not permit the rent to increase or reduce in line with the current market prices. The landlords can increase rent based on consumer retail index and retail price index, but this can be restricted by governments price ceiling as well as agreed collars and caps. When the rent increase based on the agreement with the lessor or as a statutory requirement, the lessee is obliged to pay the increased rent.

Obligation Repair and Insure

Landlord and Tenant Act of 1954[6] permits tenants of commercial properties the security of tenure. If the tenant has occupied the property for the business purpose, as it is the case with Cautious Investment retail property, the tenant is guaranteed the occupation of the property until the end of the lease term (Carr et al. 2010). This security of tenure requires the tenants to repair the property in case of any damage to restore its original condition. A tenant of the business property is responsible for repair and maintenance costs (Designing Buildings Ltd. 2018). The tenant or the landlord can insure the property. However, when the landlord insures the premises, they should recover the cost of premiums from the tenant (Newin 2019). Full repairing and insuring allow property owners to receive streams of income without meeting additional expenses.

Use Property for Specified Purpose

If the tertiary property has been specified to be used for the retail purpose, it cannot be used for residential purposes (O’Connor 2013). The retailers on the ground floor of Cautious Investment Property can use the premises only for business purpose. If the tenant breaches this covenant, the landlord is entitled to seek court intervention to be awarded damages (Carr et al. 2010). This might come in addition to injunction or specific performance.Order Now from Course ResearchersAsset Management Strategy

Cautious Investments is complaining of the reduced returns. The company can overcome by employing the right asset management strategy, which can be determined through scoring matrix based on 20-year period cash flows. The financial pressure facing Cautious Investments can be linked to Brexit, which RICS (2019) attributes to the fall on demand for retail, commercial property. With the population in London continuing to increase, and the demand for residential services increase, the tertiary residential property investment is likely to be a profitable investment in future.  Cautious Investments Ltd should give the residential lease the priority.

 Asset Management Scoring Matrix

Description Net Present Values of cash flows (£)
Option 1: Retain the status quo Option 2: Convert Property to Retail Convert Property to Residential
Final property disposable value (5% price increase annually).

Conversion cost

Rising Voids

Lowering of returns

Improvement opportunities

Diversification

Legislative impacts (Betting)

6,410, 812

 

0

-500,000

-400,000

600,000

400,000

-200,000

5,130,500

 

-400,000

-1,000,000

-1,600,000

200,000

0

-600,000

8,980,537

 

-500,000

-100,000

0

1,200,000

0

0

Total cost 6,310,812 2,730,500 9,580,537
Net Present Values 654,221 283,062 993,183

 

Based on the yearly return of 12 per cent, converting the property to residential yields the highest Net Present Value. The figures used in the scoring matrix are based on the current market price of the tertiary commercial property in the outskirts of London as well as major towns in England.

 Part B: Rent Arrears Strategic/Operational Model

The low returns experienced by Cautious Investment might have risen from the poor performing retail market.  IG Bank (2019) argues that UK commercial property has been facing uncertain times since the wake of Brexit. This has also led to a decline in commercial property investment, as presented by (Savills 2020). The underperforming retail market increase the certainty of Cautious Investment facing the challenges of increased rent arrears; hence, reduced rent income collection. As such, the company should focus on reducing and preventing the occurrence of arrears. To avoid rent arrears, Cautious Investment can: prevent tenants from getting into arrears and reduce the funds owned by tenants in arrears. The company will also need to equip the tenants with essential information, advice and support on how they can maximize their earnings to prevent debts such as rent arrears.

While managing rent arrears, Cautious Investment should employ preventive and proactive approaches rather than reactive measures as put forward by (Department for Communities and Local Government 2016, p. 2). This will help to avoid arrears that could be prevented by adopting less costly measures. For example, Cautious Investment can simplify the rent payment process. It can have the rent payment management plan with the tenants facing financial difficulties by allowing them to make weekly deposits. The flexible rent payment approach will help to retain tenants who might face income challenges at certain months of the year (Crosby et al. 2016). The company should regularly assess the drivers of rent arrears and adopt necessary measures to correct the causes. For example, the delay in payments might be due to irrelevant and ineffective services that lead to customer dissatisfaction. When the tenants have failed to pay the rent within the agreed-upon time, the company should keep on reminding them that they are in arrears since the last rent payment. Eviction of the tenants might also be an option for Cautious Investment if all other measures have failed, as argued by (Gerull & Salomon, 2014). However, evicting the tenants might destroy the company’s reputation. Therefore, it should only use it as a last resort.

The proactive approaches to avoid or reduce rent arrears might not work in all instances (AWICS 2018). When the company such as Cautious Investments face rent arrear management problems, it should consider several measures, including adopting strategic approaches such as discussing with the tenants in arrears on how they find it appropriate to clear their debts. The landlord should give them flexible payment procedure, including allowing them to clear their arrears in instalments (Scanlon & Kochan 2011). The landlord can also empower the tenant in arrears to clear their rent by giving them rent incentives as well as reducing the amount they should pay (Wilson 2019). Cautious Investment will also need to help the tenants in arrears to maximize their income so that they can clear their debts. For example, the company can advise their clients to consider acquiring loans to revamp their business operations to increase the earnings.

Maintaining open and regular communications with the tenant in arrears is essential since it allows the landlord to update them about their arrears (Sanderson & Edwards 2016). To facilitate communication, the lessor should maintain the tenants’ arrear letters and personal contact, repayment agreement terms as well as other forms of communication. The landlord can opt for other arrear payment strategies such as legal and court processes (Baxter & Murphy 2018). However, before taking this action, the lessor should assess the cost-effectiveness of the process. This will include assessing associated processes cost and the benefits. If the costs outweigh the benefits, it will be appropriate to record arrears as bad debts. If the legal process benefits are more than the costs incurred, then the lessor should consider requesting for various arrears collection methods, including holding the tenant’s property in lieu as well as seeking damages.

In minimizing the cases of rent arrears, Cautious Investments should adopt both proactive and reactive measures. As much as the company will try to prevent rent arrears using the proactive measures, there are times when the tenants will fail to pay perhaps due to economic downturns and income-earning determinants. This report presents the simplified model below, which Cautious Investments can use to manage rent arrears effectively. The model comprises of the actions that the company should execute, the amount in arrears, target date, the goals, potential outcomes and measurement parameters.

Rent Arrears Strategic/Operational Model
Action Target Date Amount in Arrears Goal Desired Outcomes Performance Parameters
Review the existing rent arrear collection strategies Continuous Exceeds £100,000 Adopt the right strategies Effective arrear collection processes Effective and efficient arrear collection
New tenants pay rent on the first day they will start using the premises Continuous Exceeds £100,000 To avoid rent arrears and bad debts Improve rent collection Rent being paid on time
Employ flexible communication ways Continuous Exceeds £100,000 To maintain communication with outcomes Effective ways of communicating with clients Customer satisfaction
Offer Residential services only December 2020 Exceeds £500,000 Increase the numbers of customers who pay on time To facilitate maximum rent income collection Reduced rent arrears cases to 10 per cent.
Adopt automated payment method April 2020 Exceeds £50,0000 To have tenants as the primary source of income Maximum rent collection Reduced rent arrears
Diversify services August 2020 Exceeds £250,000 To increase property value Cushion against rent arrears Little impact of rent arrears on income
Focus on reducing housing voids Continuous Exceeds £30,000 Put property into maximum use Reduce rising voids Increase rent income collection
Review the cost of rent and arrears collection Continuous Below £20,000 Reduce rent collection costs To avoid unnecessary costs Maximized rent income collection
Consult customers on the appropriate rent collection methods May 2020 Exceeds £50,000 To involve the customer in the rent collection process To increase customer satisfaction Reduced rent arrears
Sign agreement at the start of the tenancy on rent payment dates April 2020 Exceeds £100,000 To achieve maximum rent collection. Reduce rent arrears Reduced rent arrears

Rent Arrears Management Flowchart

References

AWICS, 2018. Management of Rent Arrears.  Available at: https://awics.co.uk/management-of-rent-arrears [Accessed 26 March 2020].

Baxter, D. & Murphy, L., 2018. The Case for Reforming Private Renting, London: Institute for Public Policy Research.

Blockbuster Entertainment v Barnsdale [2003] EWHC 2912, [2003]

Carr, H., Cowan, D., Hunter. C. & Wallace, A., 2010. Tenure rights and responsibilities, Bristol: Joseph Rowntree Foundation.

Crosby, N., Hughes, C. & Murdoch, S., 2016. Flexible Property Leasing and the Small Business Tenant. Journal of Property Research, 23(2), pp. 163-188.

Department for Communities and Local Government, 2016. Guide on Effective Rent Arrears Management, London, UK: Department for Communities and Local Government.

Designing Buildings Ltd., 2018. Leasehold covenants. [Online]  Available at: https://www.designingbuildings.co.uk/wiki/Leasehold_covenants [Accessed 25 March 2020].

Gerull, S. & Salomon, A., 2014. Evictions Due to Rent Arrears: A Comparative Analysis of Evictions in Fourteen Countries. European Journal of Homelessness, 8(2), pp. 137-155.

Go West V Spigarolo [2003] QB 1140, [2003]

IG Bank, 2019. How is the UK commercial property sector performing?. Available at: https://www.ig.com/en-ch/news-and-trade-ideas/shares-news/how-is-the-uk-commercial-property-sector-performing—-181127 [Accessed 26 March 2020].

Independent Chartered Surveyors, 2017. Commercial Property: What is a Primary, Secondary or Tertiary property? London: 1stAssociated.co.uk.

Landlord and Tenant Act 1954

Landlord and Tenant Act 1988

Landlord and Tenant (Covenant) Act 1995

Maass, S.-M., 2017. Rent Control: A Comparative Analysis. Sue-Mari Maass, 15(4), pp. 41-231.

Newin, J., 2019. Real Estate Law Review, London, W11: Law Business Research Ltd.

O’Connor, A., 2013. Capturing the benefits of common ownership: Landlord and tenant law in commercial property portfolios, s.l.: s.n.

RICS, 2019. Q2 2019: UK Commercial Property Market Survey: Retail pressure shows no signs of abating, London: RICS United Kingdom.

Sanderson, D. C. & Edwards, V. M., 2016. Determinants of satisfaction amongst tenants of UK Offices. Journal of Corporate Real Estate, 18(2), pp. 102-131.

Savills, 2020. Market in Minutes: UK Commercial. Available at: https://www.savills.co.uk/research_articles/229130/294855-0 [Accessed 26 March 2020].

Scanlon, K. & Kochan, B., 2011. Towards a sustainable private rented sector: The lessons from other countries, London WC2A 2AE: LSE London.

Wilson, W., 2019. Rent setting: social housing (England), England: House of Commons Library.