A lawyer’s-eye view of the commercial real-estate market
By Maciej Boryczko, partner, attorney-at-law, and Iwona Gielo-Benza, senior consultant, Gessel
Recent times have been difficult for the commercial and service rental industry. And it looks like this trend will continue in the near future. The pandemic has left its mark, which resulted in the closure of shopping malls and retail parks, limiting the number of visitors, disrupting the supply chain or increasing involvement in completing formalities for subsequent lockdowns (typically offers to extend the lease terms!). The current perspective – Russia’s invasion of Ukraine and its socio-economic implications – is not encouraging either. As lawyers involved in servicing the rental market, we see that landlords and tenants have numerous concerns related to the current political, economic and social situation.
These concerns force making analyses of commitments, verification of needs and consideration of changing the strategy of actions. The current reality poses challenges for all market stakeholders, including their legal advisors. Recent events have reminded us that there is nothing permanent in business, that in the case of contracts, the most important thing is flexibility – trying to address unpredictable situations, and providing a protective umbrella against risks. Also, as recent history shows, the theoretical ones. As lawyers, we observe a trend of revising lease agreements, both in terms of model agreements used by individual entities and in relation to the provisions of agreements already in force. Particularly interesting and topical issues are those related to settling costs – in the face of unprecedented inflation in the 21st century – contractual clauses in this area are very different.
We observe that the warehouse rental market is in the best condition. In the office leasing sector, affected by the pandemic, we may see some stabilisation, but in Poland, the regulations on remote work have just entered into force, which may encourage tenants to use this solution more widely and thus reduce demand for rented space. Another disadvantage we observe in this sector in Poland is the lack of large (over 2,500m²) modern office spaces in the premium class; these are increasingly sought after by large tenants. Speaking of commercial rentals, one cannot forget about the cinema industry, a great victim of recent years. Cinema owners are alarmed by the disastrous situation in their industry caused by a drastic increase in operating costs and a decrease in the popularity of cinemas in favour of streaming platforms that offer relatively cheap access to entertainment. In the catering leasing sector, according to our clients, the situation is even worse. Very high costs of utilities, high rent and service charges, increase in food prices and high cost of employment call into question the profitability of this business. Many tenants are already deciding to give up their leases and close or reduce their operations.
Poland’s commercial and service rental market is changing. Fewer and fewer shopping malls are being built now, in fact, none; while the segment of smaller facilities is developing dynamically – retail parks grouping up to a dozen or so tenants and so-called convenience centres. We may also see the flourishing of discount chains, perfectly fitting into the current consumer needs.
We want to point out two key factors affecting the retail and service space rental market which can be regulated contractually.
The first is a significant increase in inflation and interest rates. On the one hand, it results in an increase in costs incurred by landlords and tenants across many areas: wages, raw material prices, supply and distribution logistics. On the other hand, we can see a weakening of the purchasing power of households, a saving trend, which may translate into a decrease in the tenants’ businesses, especially in the fashion industry. However, the situation is improved by the large number of immigrants from Ukraine who increase consumption rates.
As far as tenants are concerned, the direct consequence of that process is an increase in rent, normally indexed in commercial leases based on inflation rates announced by the European Statistical Office or by GUS, Poland’s central statistical office. Inflation and high interest rates also affect the increase in joint charges or service charges incurred by tenants as a share in the costs of maintenance and operation of the building in which the rented premises are located. Next to rent and energy costs, this is probably the biggest burden on the tenant’s budget.
The second important factor is the drastic increase in energy and heating prices, which significantly affects the total rental cost as a result of higher utility bills and increased service charges. This growth is particularly painful for the catering leasing sector, but also for low-margin tenants. Assuming, rather conservatively, that the increase in costs in this area amounted to about 30%, the problem can be seen at first glance.
From the perspective of tenants, the appeals made by industry organisations to landlords to freeze rent indexation in 2023 and transparent rules for settling common fees are understandable, for example, such an appeal was made by ZPPHiU, the Association of Polish Employers of Trade and Services. We keep receiving signals that tenants also individually apply to landlords to renegotiate lease agreements, including to stop indexation of rent in 2023.
It is very good now to have the limits on indexation and increase of fees set in contracts (e.g. through a flat-rate form of the fee, setting an upper limit for increasing or settling advances for common costs, etc.). Those tenants who have managed to negotiate and sign contracts with such provisions may consider themselves winners.
The landlord’s perspective is completely different. Their costs should be fully passed on to tenants. Such a model is one that landlords strive for and understand. The economic and social processes described above significantly increase the costs of maintaining and operating shopping centres and retail parks. Landlords, especially those in large-format malls, who have been hard-hit during the pandemic, and who mostly finance themselves with credit, may have to verify the prospects of tenants. As it seems to us, a particularly difficult time awaits the fashion industry; signals coming from the market are worrying. Tenants in a disadvantaged situation or in industries at risk of declining revenues will become less attractive to landlords.
As a consequence, landlords may have to part with some tenants. As far as this is concerned, the landlord may face numerous restrictions. The standard in this type of leases is entering into fixed-term agreements and the enumerative, quite narrow, determination of the reasons for terminating the agreement. Such agreements are considered more durable than open-ended ones. This results from Polish Civil Code 673 paragraph 3 which provides that in the case of leases for a definite term, both the landlord and the tenant may terminate the lease in the cases specified in the agreement. The possibility of terminating the lease by either party at any time without giving the reason is excluded. Putting in the agreement a properly defined catalogue of reasons for termination often saves the parties from the continued burdensome legal relationship, and often from financial problems. Such provisions often belong to the longest negotiated catalogue of clauses.
Contracts are written for bad times. We have the impression that such times have come or may come soon for the commercial and service leasing industry. Dark clouds may be seen on the horizon. And when business ceases to be ‘as usual’, everyone invokes the contract.