Look Back In Anger

Further tinkering with landlord and tenant legislation will onlycripple the commercial property market, warns Roderick Nowlan

People's eyes tend to glaze over when the subject of Nama and its property portfolio is broached. Throw a possible retrospective adjustment to landlord and tenant legislation into the mix and you will have lost most of your audience. However, the interaction of these two issues has the potential to cost the state over €2.8bn in one fell swoop – almost three times the proposed public-sector pay cuts or a bill of €1,905 for every household in the country.

Following the recent abolition of upward-only rent reviews by the minister for justice, the same lobby group which sought this legislative move (the Grafton Street Traders and Retail Excellence) is pushing the minister to extend this change in law to retrospectively adjust review clauses in existing leases. Such a proposal would have dire consequences for the Nama process and holders of existing investment property. It would also probably be subject to constitutional challenge.

The proposal would dramatically reduce the value of almost all income-producing Irish property assets, including those transferred to Nama. Due to the fixed valuation date of 30 November 2009 all these transfer values will have been assessed on the assumption that leases contained valid upward-only rent reviews. Consequently if the lobby group were to be successful it would mean that Nama would effectively be overpaying the various banking institutions.

The principle reason for this value reduction is as follows.

Given the significant downward adjustment in rental values over the past two years the majority of income-producing property assets are what is termed 'over-rented' (rented above current market rental levels).

In these instances when such property assets are valued, the valuers will approach the valuation by determining first the true market rental value of the property and then effectively splitting the valuation into two elements, namely:

● That value attributable to the likely income flow from the property based on its true market rental value (hardcore element).

● That value attributable to the likely income flow from the property from the over-rented element (froth element).

Depending on the degree of over-rentedness, the duration the specific tenant is contractually obliged to pay this 'froth rent' and the strength of the specific tenants covenant, this froth element could contribute as much as 50% of the overall value of a property. This portion of all income-producing property assets' value would be immediately eliminated should upward-only rent reviews be retrospectively abolished, having a catastrophic effect on Nama and the projections of the minister of finance as to its likely performance.

Nama will pay about €14bn for domestic income-producing assets. Of this I would estimate the overall froth element would represent 15%-20% of this value. Consequently, the retrospective removal of the upward-only provision could result in the immediate elimination of this portion of the value which would represent a loss to Nama and ultimately the taxpayer of between €2.1 and €2.8bn.

This small matter aside it's important to consider the beneficiaries of such action. It would comprise tenants across all commercial property sectors including retail, office and industrial property. It is widely accepted that the effect of rent on business viability in the latter sectors is nominal. In addition it is clear that the majority of retail tenants are in a position to bear the burden of the froth rent due to the existence of other profitable stores. Consequently, such arbitrary action would benefit those tenants who do not require any support, but at significant cost to the Irish taxpayer. In addition, there is already widespread support from landlords, by way of rent reductions, for retailers where the rent level is jeopardising the retailer's business.

It is worth noting that interference with freely negotiated landlord and tenant arrangements has led to unforeseen and usually unhelpful results. For example, the rent freeze introduced in the 1970s in the UK led directly to a secondary banking crisis. Around the same time in Ireland Richie Ryan introduced a directive to the OPW that all state leases (of property) were to have upward and downward reviews. This measure was subsequently rescinded after a few years due to its unhelpful consequences.

The negative implications of such retrospective action on the international investment community's perception of Ireland are of greater concern. This could damage the prospects of any future external investment in the Irish property market. The direct incontrovertible implications of this will be to restrict Nama's future ability to refinance or dispose of its property portfolio to non-domestic investors.

Finally, it is important to note that the financial impact of retrospective action on the citizens of the state is not limited to its impact on Nama. After Nama, the single-largest collective beneficiary of income-producing property assets in the state would be pension funds and insurance companies. The impact of such retrospective action will be to further erode citizens' pension funds and to increase the cost of all forms of insurance to both business and private individuals.

It all sounds too ridiculous to gain any traction. But so did the abolition of upward-only rent reviews which, as predicted, proved to be of absolutely no assistance to our ailing retailing sector or of any relevance to the existing real market which had long since removed the clause from new leases. The prospect of the introduction of a retrospective proposal will have a detrimental impact on the recovery of a long-floundering commercial property market. For this reason alone the proposal needs to be quashed as a matter of urgency.

I am sure there are law firms throughout the country licking their lips at the prospect of taking an action against such a government move.

Roderick Nowlan is investment director with property consultants Bannon

May 23, 2010

Comments

#1 Dublin Barrister commented, on May 24, 2010 at 11:49 a.m.:

This article is the usual property-focused rubbish that estate agents like to peddle. It is total tripe and seems to move from the premise that the poor should always bail out the rich when they make mistakes and lose all their money. Shame on you, oh employee of property consultants Bannon.

#2 Dave commented, on May 24, 2010 at 3:04 p.m.:

Wonder if "Dublin Barrister" is part of the small interest group looking to get released from their contractual obligations. Could I get off my neagative equity mortgage while your at it (which just isnt fair etiher)!!!

#3 John Corcoran commented, on May 25, 2010 at 11:13 a.m.:

On the road back to economic recovery,upward only rent reviews are a suicidal form of self sabotage.

Mr Nowlan has handed his opponents a Rod to beat him with

When this generation has passed away and the tongues of praise now cease --it shall be written -that the Grafton Street tenants walked with the Irish people ,in their vast diversity ,and helped with their great going forward

#4 Edmund Ross commented, on May 25, 2010 at 4:37 p.m.:

Those faceless landlords are indirectly inflating the value of goods for sale and in denial of the state of affairs here in Ireland The least one should expect is a temporary reduction in rent retrospective from the year 08 when the decline in consumer purchase became an overnight dilemma and has continued to decline.It is not possible therefore to trade competitively .Common decency and moral conscience together with a pragmatic attitude to traders caught in this draconian situation should be accomodated rather than allow the inevitable liquidations continue.
Is it not better to see shops remain open? No where in europe adopts such an unfair upward only rent review .In fact rents go up and down according to the state of the economy and are usually linked to a percentage of the shops turnover.This would be a fair way of resolving the situation now and in the future.

#5 helena commented, on May 27, 2010 at 1:02 p.m.:

I would have thought that this type of "three card trick" economics SHOULD have declined in popularity! Froth aka uneconomic rental is not sustainable in the long term.

#6 Marie commented, on May 27, 2010 at 6:34 p.m.:

Professor David Morgan of University College Cork , a legal property expert has stated that the law banning Upwards Only Rent Review clauses does apply retrospectively in that it will apply at all future rent reviews. Mr. Nowlan and his property consultant/estate agent colleagues would be better served in supporting the Government in its attempts to save Irish retail business and jobs instead of encouraging FROTH rent levels to continue. Another way for the Government to go would be to tax these windfall profits untill all these illegal leases run out.

#7 John Corcoran commented, on May 28, 2010 at 12:45 p.m.:

The most important contract most people sign is their marriage contract.

When divorce was legalised in Ireland it was retrospective,it affected prior marriage contracts

#8 rory commented, on May 28, 2010 at 11:13 p.m.:

The commercial property market is kaput and the banning of upwards only rent clauses was an attempt to unto the damage caused by this clause as worked by the agents. This article is based on an upside down view of the world and displays the sort of logic that landed us in this mess. A wind swept Island with a small population should not have some of the highest rents in the western world. NAMA is an argument for bursting the bubble not sustaining it.

#9 rory commented, on May 29, 2010 at 7:27 p.m.:

Mr.Nowlan needs to get out and about. The property bubble inflated by this review clause has cost the state billions,its banks, its prosperity and even perhaps,its future. It is scary that these property experts cannot see the folly of what they have done. Would someone please hide the pen and paper.

Roderick Nowlan is investment director with property consultants Bannon

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