Blacks and La Senza: Aggression vs Seduction?

Yesterday saw the first of what will most likely be a wave of pre-pack administrations of high street names when both Blacks Leisure and La Senza went into administration and immediately thereafter their businesses (or at least the profitable parts of it) were sold to willing buyers.  Pre-pack administrations have come in for a lot of criticism on the basis that they often, if not always, return no value to unsecured creditors or shareholders.  However, they have their merits and, in a lot of cases, genuinely achieve the best result possible overall for stakeholders.  Therefore, much to the dismay of some readers, I am not about to launch into vitriolic criticism of the use of pre-packs to save jobs and businesses with unsecureds being left high and dry.
There is, however, one common thread of both the La Senza and Blacks pre-packs which are worth highlighting and, as a landlord, preparing for: lease renegotiations.  In the case of Blacks, the official press release from JD Sports Fashions stated:

"Following the elimination of any underperforming stores and other cost reduction initiatives we believe the business can be run successfully as independent fascias within the Group."

With La Senza, less than half the retail sites leased by the group were bought out of administration with the majority of sites closing down so, it is likely, only the performing stores were part of the original deal.  However bearing in mind the official press release which stated:

"Today’s announcement represents a first step in a long-term commitment to developing the La Senza UK business, which we believe has great potential."

it seems likely that 'new' sites are on the cards.
My prediction is that in both cases landlords will be approached by the new owners to renegotiate lease terms.  What we have is a difference in approach from the new owners; one is seeking to pressure landlords whilst the other is seeking to seduce them.
In the case of Blacks the new owners have probably taken a licence to occupy all the sites and will now meet with the landlords of "underperforming sites" to seek to renegotiate the leases.  This will be the stick or 'Aggression' based approach; if the landlord does not agree the terms the site will be closed and the landlord left with the void costs, which would include empty rates liability, service charge irrecoverability and an unoccupied site which quickly becomes unattractive.
In the case of La Senza whilst landlords of transferring sites might be approached, bearing in mind the number of up front closures, I anticipate that the new owners will approach landlords of some of the closed sites and propose new terms under which they would be willing to re-open.  This is more of a 'carrot' or 'Seduction' based approach offering to relieve landlords of the void exposure.
As a landlord it is important that you are aware of what your negotiating position is in respect of any approaches.  It is worth keeping the following in mind (and get detailed legal advice in respect of them where relevant):

• an administrator has no right to disclaim or unilaterally surrender a lease or otherwise bring a lease to an end earlier than a solvent tenant (only a liquidator has that power).  Therefore rates liability in particular should not fall on a landlord simply because of the tenant going into administration although ultimately liquidation is likely).
• if the property is still being used (and this is particularly important in the case of Blacks) then the lease liabilities arising are likely to be an expense of the administration.
• due to the decision in Goldacre expect there to be significant pressure to get deals done before rent payment dates as administrators in particular will wish to ensure that they can avoid any risk of the next period's rent being payable as an expense in whole.  My view is that a challenge to Goldacre or an attempt to extend it is very likely this year.
• pre-conditions or requirements set out in the lease as things which the landlord can rely on in terms of refusing consent to an assignment apply to an assignment by a company in administration just as much as they do in non-insolvency positions.  Obviously a balance is to be achieved but if you really do not want to consent to an assignment or the proposed terms don't think you will have no choice in the matter.
• the courts will not be quick to grant consent to forfeiture.  In our experience to date courts have given administrators quite a long time to try and assign a lease so even where the proposed assignee cannot meet lease pre-conditions do not assume the courts will be on your side.

La Senza and Blacks might be the first major retailers of 2012 to go to the wall but, if the reports are to be believed, they certainly will not be the last.  Whether buyers of such portfolios use might or seduction methods to seek new lease terms we can only speculate but what La Senza and Blacks show is both approaches are being considered and pursued.  Either way, make sure you use protection!

Retail 2012 – a showdown between administrators and landlords?

A very experienced insolvency practitioner who has acted as administrator on some of the most high profile insolvencies of well known British retailers recently mentioned to a colleague that:

“The main problem facing retailers today is that rents are too high.  Landlords will need to accept that if they want their businesses to survive they will need to reduce significantly the rents payable.”

There is undoubtedly truth in what this IP says; if landlords reduced rents then margins would increase and/or retailers could reduce prices to make their goods more attractive to you and me.  There we go then; in one foul swoop we can fix the problems of the high street, make British retailers more profitable thus increasing tax revenues for Her Majesty and, as Gordon Brown once said “save the world” .
There is just one small problem with this hypothesis; in reality it is nothing more than window dressing.  Put another way, what is being suggested is in effect seeking to simply alter a different variable in a rather complicated equation where ultimately the same final answer always applies:

TRS = RP + BI + LP + BI;

where

TRS = Total Retail Spending;
RP = Retailer's Profit;
BI = Bank Interest; and
LP = Landlord’s Profit.

This is obviously an oversimplification of where the money spent on the high street actually goes but it is sufficient to highlight that by reducing rent what in effect happens is that LP decreases so that RP increases.
This equation also highlights another important factor; that of Bank Interest.  This affects both retailers and landlords alike and once again highlights that in reality the real issue which is damaging the High Street is debt.
In fact the one common factor affecting all three contributors to the equation (retailers, landlords and, just as importantly, the consumer) is debt.  Therefore the IP quoted above could have been more accurate if he had stated that the main problem facing retailers today is that there is too much debt in the economy.  So why not say this?
A number of answers spring to mind (in increasing accuracy):

1. IPs are generally appointed at the behest of the banks.  It would hardly be sensible for IPs to bite the hand that feeds them.
2. Banks have already taken significant hits so is it realistic to expect them to take further hits?
3. Landlords rely on tenants.  If tenants cannot pay the rent then landlords will ultimately lose out.  High rents can only be justified if there is a willing tenant.

I believe that the IP quoted was expressing the view that the average level of rents on the high street is so high that it is not reflective of the economic realities in which we live and were we to test the market then the average rent would fall significantly.
He is right but averages are misleading.  In reality there are a lot (easily the majority if not the vast majority) of retail sites where the rent is too high and should be cut.  However, there are a lot of sites where the rents could go higher as the landlord could easily re-let the property to another retailer if it became available.  Bond Street is an example but so are certain locations on Oxford Street or in major shopping centres such as Westfield London or Bluewater in Kent.
A recent review of the high street predicted a significant increase in the number of retail insolvencies in 2012.  The prediction is that those retailers with 50-500 stores will be worst hit.  What this is likely to mean is that CVAs which had been utilised a lot in 2007 and 2008 to save a number of retailers (or at least delay their demise by a year or two) is less likely to be successful.  If the IP is right in order to survive these retailers will need to do more than simply close sites; they will need to reduce the rents on a significant number of sites that are to remain open.  This is yet to be achieved through a CVA and the most well-known attempt at such a large scale CVA routed rent reduction (Stylo in 2008) was a total failure.
Therefore we are more likely to see a significant increase in administrations (as we have already in the last few weeks).  The courts to date have provided a significant amount of leeway to administrators by protecting them against claims for forfeiture by landlords even where landlords have been able to show they have alternative tenants to the administrators’ preferred assignee.  However landlords have seen some successes; most notably in the case of Goldacre (Offices) Limited v Nortel Networks (UK) Limited.  Yet even this decision is now being turned by administrators to their advantage with a refusal to pay any rent for the quarter during which they are appointed on the basis that they are appointed after the quarter day.
My prediction for 2012 is that we will see this issue and many other similar issues relating to the rights and obligations of administrators to make use of premises litigated through the courts.  So 2012 may prove bad for the high street but it is likely to provide ripe pickings for the IPs, real estate insolvency lawyers (like me I must admit) and real estate litigators.  Every cloud must have a silver lining; at least for some of us.

In defence of sale and leasebacks post Southern Cross

The Southern Cross collapse has cast a very strong spotlight on the use of sale and leasebacks in the care home industry and in property heavy businesses in general. Southern Cross is not the first well known name to collapse with a sale and leaseback business model; remember Woolworths? Or going back further the Forte group? But, whilst all these collapsed entities share a common theme in having utilised sale and leasebacks it is flawed to conclude that any entity which undertakes a sale and leaseback is primed for collapse and, as a response, call for such arrangements to be heavily regulated or outlawed.
How do you justify a sale and leaseback?
First of all it is important to understand the rationale for undertaking a sale and leaseback. In simple terms it is about efficient and productive use of equity. Simply put owning a property outright means your capital is tied up in an illiquid asset. It also means that not only are you running an operational business but you are also exposed to the property investment market with the value of your property fluctuating with property values generally. When the building comes to the end of its useful life (which modern buildings appear to do in a very short space of time) you then have to go to the expense of redeveloping it or selling the land for development.
Extratracting value by borrowing and securing the loan against the property might deal with the immediate issue of cash being trapped in an illiquid asset but it does not deal with the other issues highlighted above. Further owning the property outright and mortgaging has a very negative effect on a company's balance sheet something which, under current accounting principles, a lease does not.
In fact, failing to use sale and leasebacks to some extent might have hampered Southern Cross' expansion.  Whilst one might argue this would have been a good thing one has to consider how, with an increasingly ageing population, having less care beds available is necessarily in the public interest.
I have been involved in a number of sale and leaseback transactions and also acquired and sold properties which have been investments created by them including some Southern Cross properties.  Sale and leasebacks come in all shapes and sizes but I can confidently say that it is not the sale and leaseback model that is the problem but rather the way it is structured and its misuse.
A lease is a very flexible instrument and property valuation more of an art than a science.  Accordingly, by varying the lease inputs in relatively small ways the capital value of a property can be increased or decreased significantly.  But sometimes you can change the same variable without getting the same results.  For example, altering the initial rent on a sale and leaseback transaction will have a greater appreciable effect on capital receipts where rent reviews are index-linked than if they are open market.
Let's consider the Southern Cross approach.  Anecdotal evidence suggests that most of their leases were relatively long term (30+ years) on a full repairing basis with index-linked rents subject to a cap and collar.  Analysing these inputs and whether they were sensible choices for Southern Cross to make I would conclude:

• Term - on the basis that you are not going to move residents around homes you need a long term.  Further the large scale capital expenditure needs a long enough period to be amortised over the life of the lease
• Full repairing - SX would need to maintain the homes in order to comply with CQC and Care Standards so this covenant is not imposing a more onerous obligation on them.  Leasing a commercial property is not about being relieved of the financial implications of repairing it it is about best use of available cash
• Index-linked rents - SX's business model was based on local authority spending.  Historically this has always risen in line with a pricing index.  Therefore linking rents to such an index is more logical than relying on either fixed uplifts or open market reviews where true comparables are very difficult to find
• Cap and Collar - These are important for certainty.  From SX's point of view a cap limited its exposure to higher levels of inflation (and bearing in mind the concerns on inflation in 2007-2009 this was a good call).  The quid pro quo to a cap is a collar to provide the landlord with some comfort that there will always be a rise.  Frankly bearing in mind actual inflation you cannot blame the collar for the failure.

So why did SX fail and is the sale and leaseback structure blameless?
The sale and leaseback structure is not blameless but the issue is more likely that SX agreed rents that were too high in the first place.  The incentive for this is clear.  Within reason the higher the initial rent the higher a price a buyer will pay.  SX extracted maximum value for each property by agreeing to pay the maximum rent which it was felt the business operated at that care home could bear; it left no room for drops in income.  Had their assumptions borne out no one would have questioned their actions and everyone would be marvelling at what a fantastic job the board had done.
However, before singling out the board of SX for criticism regarding their assumptions let's not forget the following:

• landlords had their own advisors who were as well placed as SX to study the demographics, macro- and micro-economics behind the business and lease structure and highlight concerns - did they?
• we had a Labour government which had continued to increase year-on-year its public sector spending in key areas including elderly care and shown no interest in reducing it (even after the credit crunch hit)
• we had Gordon Brown as chancellor telling us he had "abolished boom and bust" and many were happy to believe him
• we had banks with apparantly endless resources able to lend at high leverage

In reality SX was as much a victim of the lax lending practices and flawed belief in our own perpetual success than a totally flawed and unjustifiable business model.  That others have survived where it failed may be more a matter of luck than judgement.
Jamie Buchan, SX's soon to be ex-Chief Executive, said in an interview with Adam Shaw on BBC Radio 4 Today this morning, that he expects changes in the sale and leaseback model in the future after their troubled experience.  Paul Pressland who responded to @AdamShawBiz's tweet said "it is simple, agree a rent you can sustain not one that gives you the greatest capital sum!".  Whilst it may not be that simple it certainly would be a good start.

I didn't do it so I am not helping tidy up

The usual line from my 5 year old when we ask him to help his 3 year old brother tidy up the toys which his 3 year old brother has tipped all over the floor is "I didn't do it so I am not helping tidy up".  If only life was so simple.

I have my suspicions that I will come in for a certain amount of criticism for some of the things I write in this latest instalment.  However, I am man enough to take it (bullet proof vest and bodyguard now in place) so what the hell.

This morning I woke up to Radio 4 and then Radio 5 (two alarms because I am rubbish at getting up and my wife gets up 15 minutes after I do and hates Radio 4).  Radio 5 started talking about how the Unions are having a big meeting to discuss potential collective action (aka General Strike) to stand up the Government and oppose the huge cuts being imposed across the economy and resulting in, as they called it, "attack on our public services".

One of the people Radio 5 spoke to was a businessman whose argument was that whilst it is true that the bankers bore most of the responsibility for the financial crisis that we are in, everyone has to shoulder the burden of getting us out of it.  He went on to say that bankers have paid a price (I believe he meant financially as well as in terms of increased regulation), that the private sector generally which is no less blameless than the public sector has swallowed an incredibly bitter pill in cuts, real time wage cuts, job cuts, profitability cuts and therefore the public sector has got to swallow its pill too.

Mr. Private Businessman, I salute you.  In truth I salute you because of a specific point that many have failed to pick up on.  The current mess we are in will not be solved by playing the blame game.  The UK is in dire straits.  It is in dire straits for lots of reasons.  Labour would have us believe that it is in dire straits solely because of reckless activities by the banks and global events.  Of course they would, after all, the downturn happened on their watch.  The Tories are just as happy to bash the bankers.

Personally I expect more from my Government.  When I make a mistake (never happens of course but when it does) I do not seek to place the blame on external events.  Instead I turn around and say, the mistake has been made for which I am obviously sorry.  That cannot be undone.  But what matters now is taking the right action together to rectify the mistake.  If I am prepared to take credit when things go well due to my actions I must also take responsibility when my actions result in things going not so well.

But more than that.  When I am acting for a client and the client makes a bad decision even if that decision was made against the best of my advice I do not turn round and say, it's not my fault and therefore I am not gonig to help you out.  On the contrary, I say to the client, this is the position let's see what WE can do to sort it out.  My success is linked to my client's success.  If my client's deals constantly go stale it does not bode well for me.

Unfortunately, more and more, both in business and in politics all we see is the blame culture.  All anyone is interested in doing is passing the buck.  We are more than happy to claim the credit when things go well but the minute it does not go according to plan we just point the finger at someone else and look to walk away.  Gordon Brown was more than happy to claim the credit for the boom times but the minute the bubble burst it was not his fault but due to "global events".  He was right, the bust was due to global events but so was the boom.

So, we are all in it together and must all shoulder the pain.  Except for one thing, and here is the real kicker, the painful part, the part which everyone hates.  We are not all in it together.  Because there is a certain group of people who have the ability to rise above it all and walk away leaving the rest of us behind; that is the very rich and beyond.  Herein lies the problem.  We live in a global economy where the richest among us have the ability to literally pick themselves up and move to another place at their leisure.  What this means is that it is impossible to get them to pay their "fair share" all we can do is get them to pay the share they are prepared to bear.  There is nothing we can do about this so forget about it.  Life sucks at times.

However, for the rest of us, including working, middle and even some in the upper class who may not be quite as upper class as they like to think, we genuinely are in this together.  I do not believe that the current Government wishes to destroy public services.  They are making difficult choices and will be certainly getting some of them wrong.  But it will help no one if every individual simply points the finger and says it was not my fault and so I should not pay. 

We may not have made the million plus holes in the dam but if we don't all stick our fingers in the holes we will all drown in the flood. . . except for the rich who can afford the helicopters to escape it.

JJB warns of financial breach - a threat to the CVA model?

JJB warns of financial breach Online Property Week
This was the headline which is sending shivers down the backs of Landlords across the country whether or not JJB is actually a tenant of theirs for a number of reasons.

1. JJB, whilst not a bell weather for the retail sector per se, is a large enough retailer that if it is failing to perform it is indicative of issues in the market generally.
2. JJB, utilised a Creditors Voluntary Arrangement (CVA) to much fanfare in 2009 - one in a line of large retailers to do so.  At the time I considered the reasons why one CVA is successful whereas another is not.  Now that the outcome of that CVA is not looking positive Landlords may be concerned regarding the other CVAs which they approved.

As a real estate restructuring lawyer the potential failure of JJB to turn itself around despite the CVA creates an interesting dimension.  The whole argument of a CVA is that the creditors overall will get a better deal than if the company entered administration or liquidation.  Creditors are asked to forgo a proportion of their debt and/or agree revised payment terms in order for the company to continue trading.

For landlords the deal has always been a difficult one.  In a retail CVA there are always some properties the company wishes to exit and the landlord is forced to decide between accepting a liquidated damages offer or taking its chances in an insolvency.  It seemed that JJB (and others like Focus DIY and Blacks Leisure) had managed to work out the correct level of compensation to pay landlords to get them to agree the CVA.

However, if companies that have been through CVAs begin to fail again a couple of years later landlords are going to be left asking themselves whether the problems facing the company where not really the leases but rather the management or the business itself.  Bearing in mind the cost to landlords of considering the CVA terms one wonders whether some will come to the conclusion that it is just not worth it and refuse to back CVAs in the future.

Only time will tell but for now anyway, all JJB's landlords are not sleeping quite so soundly at present.

Fee cutting is no way to emerge from recession | Analysis - print | Property Week

Fee cutting is no way to emerge from recession Analysis - print Property Week

Giles Barrie, in his editorial this week, raises some interesting points regarding the effects of fee cutting in the agency world.  The same phenomenon can be seen in the legal world for the same reasons and with the same fundamental risks to buyers of legal services.

Cutting fees is bascially an attempt to grab market share by low balling now with the hope that the client will continue to instruct you when times are better and you charge more for the same service.  Understandably many buyers are attracted by the low rates on offer but before rushing to buy the cheapest service they do need to consider what they are getting at such a cheap price.

Some issues include:

• Many of the problems that are being identified now with properties should have been spotted previously but due to time, cost and deal pressures they were not.  Taking the cheapest quote is simply repeating the mistakes of the past.  Now is the time to ensure you are getting the best advice for your circumstances as a mistake now could cost a lot more than the few pounds saved in fees.
• In order to remain profitable a firm offering a cheap quote will be forced to push the work down to the lowest level possible.  I have heard of one firm hoping to put in place data capture systems which would enable all leases reviews to be carried out by trainees.  No disrespect to trainees but no matter what technical systems you have an inexperienced trainee is unlikely to spot where a rent review clause is defective or whether there might be a Good Harvest issue in the drafting.

From the suppliers' side such low balling also creates issues:

• It creates the impression that little or no skills are required for the work - if this was the case then law firm's indemnity insurance would clearly not be as high as it is!
• It demoralises staff who know that they are effectively providing a service for which the clients are not paying.  They constantly feel under pressure to cut corners to improve profitability further increasing the risk of negligence and resent the fact that they cannot do a proper job as the fees do not allow it.
• Do you honestly believe that a client having instructed you because you were cheap will stick with you when you hike your prices on the basis that you are going to offer the same service?

Therefore, as Giles notes in the agency world, fee cutting in the legal world is damaging for both customer and supplier in the long run although I suspect will continue to be the case as many fail to recognise the risks.

Rent is an administration expense - but at what cost?

A recent decision in the High Court (Goldacre (Offices) Limited -v- Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch.)) has confirmed that where an administrator makes use of a leasehold property the rent reserved by that lease will be an administration expense. This is in accordance with most practitioners' prior views.

However, the case did decide some other related points which are, in some ways, surprising as follows:

1. the amount of rent which becomes an expense of the administration does not relate to the area occupied. Use of a small part of the premises demised will make the whole rent reserved an expense of the administration;


2. if the administrator is using the premises on the rent payment date then the whole period's (e.g. quarter's) rent will be payable as an administration expense even if the administrators' use ceases during the relevant period.

These two points could have interesting implications. The corollary of (1) might be that where the premises are part sub-let and the administrators continue to use the other part then it may be that the administrators are exposed to the credit risk of the sub-tenant default. The corollary of (b) might be that where the administrator is not using the premises on the rent payment date then there is no liability for the rent as an expense even if the premises are used for the remainder of the relevant period.

Neither of the above points were directly addressed in the judgment.

It should be noted that the fact that it is now confirmed that rent will be an expense of the administration if the administrators are using the premises does not mean that the administrators have to pay it on the due date and in full. This is still dependent on there being sufficient realisable assets out of which the rent can be paid. This was expressly confirmed in the judgement.

So whilst the case confirms a generally held belief it has muddied the waters for both landlords and administrators in some regards and altered the balance of power slightly but with the administrators arguably still holding the upperhand through the benefit of the moratorium.

Tenant CVAs - what makes them acceptable?

This year has seen a new phenomenon being cemented on to the toolkit of the struggling retailer which, in my opinion, was not anticipated prior to 2009 - the large retailer Creditors Voluntary Arrangement (CVA).

For those not necessarily in the know a CVA is effectively a binding agreement reached between a company and its creditors where the creditors will agree a delayed repayment and/or write-off of debts. The agreement is limited in time (a maximum of 2 years) and is monitored by an independent party. For creditors generally (and most importantly unsecured creditors) the process is preferable over administration or liquidation since in those processes the likelihood is that the unsecured creditors will get little or no p/£ of debt. The attractiveness for secured creditors is that it is cheaper than administration and thus should protect the value of the secured assets within the business whilst they retain their security over them.

The year started off very badly for the CVA when, in February, a CVA proposed by the administrators of the Stylo Group (then owner of the Barratts and Priceless shoe chains) was voted down by its creditors and most vehemently by its landlords. At that point one would have been forgiven for thinking that the view following the Powerhouse decision that CVAs were not appropriate where significant leasehold property interests were involved.

However, since the Stylo CVA proposal was defeated quite the opposite has occurred with successful CVAs being agreed on a number of large retailers including JJB Sports and Focus DIY. The latest instalment is a vote today by the creditors of Blacks Leisure on its CVA proposal. It is anticipated that it will be successful (see FT.com article).

The question is what is different about the post-Stylo CVA proposals that have made them successful where Stylo failed? Is it that the market has changed? Is it that Stylo simply broke a taboo and after venting their anger at Stylo landlords have since been more agreeable?

The answer is most likely a mixture but when you look at the detail of the proposals there is a fundamental difference between the unsuccessful Stylo proposal and the other successful proposals. That difference is money and control.

In Stylo every single landlord would have lost out as the proposal involved changing all rents to a turnover rent initially at 3% increasing to 7% (very low levels compared to normal turnover rents) and without a floor. Landlords were invited to seek to obtain better deals in the market and if successful Stylo could either match the deal or surrender their lease. The good news on the Stylo deal was that there was no landlord immediately facing a closed store with irrecoverable cost. The bad news was that the income landlords would obtain was totally dependent on the performance of the tenant. For stores with little or no likelihood of re letting in the medium to long term this was probably okay as at least void costs were avoided. But for landlords of stores that were in good areas the reduction in rent was unacceptable.

Moreover, Stylo was not guaranteeing that every store would then be safe as it sought an ability to surrender those stores it chose during the life of the CVA. There was to be no compensation to landlords for taking back their stores and no protection from void costs. It is probably this exposure that was the ultimate issue for landlords.

Compare that to the successful CVAs which have some or all of the following features:

• No additional store closures over and above those that had already closed (i.e. landlords knew if their site was closed)
• No rent reductions although movement to monthly rent payments
• On closed stores the tenant would continue to pay the rates (landlords were protected from this oppressive liability)
• A pot of money (normally equal to 6 months' rent) was distributed between the landlords of closed stores as compensation

The difference is huge. On the successful CVAs Landlords knew where they stood immediately. Closed store landlords knew that in an administration they would get nothing whereas in the CVA they would get compensation and be protected from void rates whilst the lease subsisted. Open store landlords were asked for concessions which they would probably have given without a CVA.

What the above highlights more than anything else is that timing matters. Clearly, for Stylo to have proposed a CVA along the lines of the successful proposals it would have required significantly more cash to cover the large expenses. This would have meant a CVA being proposed a lot earlier than it was. In the end the timing was wrong. To have a successful CVA you need to have sufficient funds to "buy off" the worst off creditors (i.e. landlords of closing stores). This requires the directors to be brave enough to recognise the issues and see the potential for a better result for creditors and stakeholders alike by taking early pre-emptive action when the company can afford it.

Whether the successful CVAs will actually result in successful companies in the future only time will tell but, at least for the landlords, the CVA was a less bitter pill in the short term.

FRI Leases in a recession - not always the protection you expect

The Financial Times reported today that "Maintenance Cuts threaten property values". For those who cannot be bothered the article what it says it that whilst UK property is generally let on full repairing and insuring tenant covenants landlords are cutting back on repair and maintaining those parts of the properties for which they have responsibility and for which they recover the cost through the service charge due to fears over whether the costs are recoverable arising from tenant default and increasing voids. Meanwhile, landlords are facing an increasing number of void units in disrepair due to tenants failing to repair and then becoming insolvent.

The failure by landlords to carry out anything but the most urgent of repairs is, of course, a double edged sword for a landlord. It exposes the landlord to the risk of tenants seeking to enforce landlords' repairing obligations (although this might be unlikely save where the disrepair is likely to damage the tenant's business). More importantly, it makes reletting the unit at the best rent very difficult since the centre in which the unit is quickly becomes dilapidated and less attractive to potential tenants. Hence, one could argue that failing to repair is only prolonging the pain for the landlord. In truth, however, landlords will probably wait until real signs that the market is picking up before deciding to carry out repairs. The timing does need to be right since if a competing location is in better repair and condition it may prove more attractive and take away potential new tenants.

Repair of individual units is even more tricky for landlords. Is there any point in carrying works of repair to a vacant unit with little chance of letting. On the other hand what chance is there of letting a unit in disrepair and what effect will this have on rent. Some landlords may opt to wait until a potential tenant is found and then agree to put the property in repair (or pay a reverse premium to the tenant to do this). This means that the level of rent should not be affected. However, a tenant looking to move in quickly (especially in the run-up to Christmas to make the most of the holiday trade) is more likely to opt for a unit ready to go.

Finally, all landlords (and tenants when landlords are carrying out works) would be well advised to check carefully the terms of service charge provisions in the various leases to check what works are recoverable and what are not. How are voids treated? What are the obligations in terms of repair?

CML slashes repossession forecasts - are they right to?

The FT this morning carries the news that the CML has slashed its repossession forecasts for the year. Let me give you a brief precis of what it says:

The CML lowered its forecast for property repossessions in 2009 to 65,000 from its previous estimate of 75,000

The CML said:

Although the economic backdrop remains challenging, the vast majority of homeowners continue to meet their monthly payment obligations. The large cuts in interest rates have benefitted many, making it easier for households who suffer a loss of income to continue to pay their bills.

This is all very nice and, indeed, the CML may be correct that their original forecast was wrong. However, do not read into this message, as many undoubtedly will, that, to quote the song by Yazz, "The only way is up" for residential property prices - I think that there must be at best stagnation and at worst (or even better for those hoping to buy) further falls to come.

The fundamentals

The boom in residential property prices was caused by a number of different factors. The most important of these were:

• demand (especially within London and the South East)
• disposable income (bonuses)
• cheap lending
• belief that values could continue to grow
• lack of housing stock

Let's consider some of these fundamentals in turn and the outlook

1 Demand

Demand for property was very high towards the height of the boom. This demand was fuelled by:

• more people looking to buy their own home
• the buy-to-let market
• expectations of windfall profits
• immigration and migration to London and surrounding areas

Most of these factors no longer exist. The buy-to-let market is still available if you have the cash to invest and are prepared to take the risk. There is no longer an expectation of windfall profits as people will be happy just to make a reasonable profit and keep a roof over their heads. Large job losses in the financial and services sectors and general downsizing resulted in and will continue to result in a decrease in movement into the UK and we may even see emigration and certainly migration away from densly populated and expensive areas such as London.

2 Disposable Income

Apart from Tube workers who believe they have a right to inflation busting pay-rises whilst the rest of the world goes to hell, most people are facing stagnant pay (or pay cuts in real terms). At the top level of the market (the banking, legal and other professionals) where pay was boosted by bonuses for so many years the size of the important bonus (if it exists) is significantly lower. Therefore, in terms of ability to pay monthly interest and/or repayment sums the amount that can be paid is less. Further the lack of job security means that the inflexible nature of owning a property with a mortgage is less attractive to, otherwise, mobile individuals.

Put in simplistic terms, there is significantly less money out there even before you consider the availability of debt.

3 Cheap lending

Not sure I even need to spell this one out. However there are actually two factors to this. First there is the fact that prior to the credit crunch the margins banks imposed on their mortgage deals were paper thin. Tracker rates below base rate were available. The reason for this was that with the magic of securitisation banks did not expect to hold on to their loan book for long so what did they care if the initial rates were 'loss-making'.

However, the Government and the Bank of England (along with other world economic leaders) have forestalled an immediate crisis caused by a sudden jump in the cost of borrowing by cutting interest rates drastically (0.5% in the UK). For those on base rate tracker deals this has resulted in them paying almost nothing (some are literally paying nothing). For those on fixed rate deals, when those deals have ended they have come on to a standard variable rate on average between 4% and 5% (about the level their fix was at in 2007). The CML has expressly stated that this is a major factor in their expectations being revised.

But interest rates cannot stay this low for too long. Predictions of deflation and very low inflation (below the BoE target of 2%) have thus far proven false. CPI is still above the target rate of 2% although the BoE have justified avoiding any rises on the basis that deflationary risks outweigh inflationary ones. This is probably correct in the immediate short term but as inflation begins to creep in (petrol prices are up significantly and at the end of the year VAT reverts to 17.5%) how long will the BoE be able to sit back and not act?

When the BoE does react (and even if it is not for a year from now) those homeowners who have been sitting on standard variable rates are in for a rather nasty surprise. Those rates will go up quickly (and quite possible faster than the base rate). Many who bought or refinanced in 2007 will find themselves in difficulty. New mortgage deals will not be open to them as the equity in their homes is likely to fall below the 25% level required to get a decent affordable deal and those fixed rate deals will continue to increase in expense. Meanwhile the interest payments will seem unaffordable as incomes stagnate and the cost of living rises.

In such circumstances will a bank avoid repossessing whilst there is potentially some profit in a sale which would cover its expenses when waiting will mean triggering a real loss on its books as values potentially fall and arrears mount? Will borrowers avoid selling to realise a small amount of equity whilst the arrears begin to rise and renting is a realistic option?

Conclusions

There is some inevitability that interest rates will rise again. Many suggest this might happen sooner than expected. When this does homeowners, loaded up with debt from the boom years which they are unable to refinance at affordable rates, will be forced to consider selling or defaulting. This will result in more properties coming on to the market on a distressed basis and this will further depress prices.

House prices in London and the South East may have cooled off but they have not really fallen. That fall will happen unless someone can wave a magic wand to make the debt disappear. As someone looking to buy I selfishly hope that magic wand does not work!

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Addendum: Check out the FT on Fitch's report that 10% of borrowers are now in negative equity. If you classed negative equity at 90% LTV (on basis that you cannot borrow 90% today) I wonder how many then fall into the trap?