While the decision of the national cabinet over a week ago on a mandatory code for retail tenancies of small to medium enterprises is welcome, it gets nowhere near addressing the urgent and dire financial challenges facing many small business retailers.
Having talked with many retailers in a range of channels since the adoption of the code, the biggest challenges are being faced by those in larger centres. Whereas many, not all but many, high street and independent landlords are agreeing deals that are usually considerably better than forecast in the code, shopping centre landlords are slow to negotiate and demonstrating no willingness to go beyond the code.
The code allows for a rent reduction based on the quantum of reduction in revenue. In one business I know of with base rent at $16,000 a month, turnover is down 50%. The code suggests a rent reduction of 50% on the basis of the revenue decline, with half of the reduction being waiver and half being a deferral.
The retailer in my example could expect a waiver of $4,000 a month and a deferral, to be paid later, of $4,000 a month. That is if their landlord is fair in their approach.
The decline hit the retailer from early March. The landlord says the code will not apply until April.
Prior to COVID-19, the business had annual revenue of $1,130,000. It’s average GP% then was 35%. Out of the $395,500 GP it paid $192,000 in rent, $143,000 in wages and $42,000 in overheads, leaving $18,000 in profit – in broad terms.
Revenue is now down 50% and is likely to fall further. In addition to the decline in revenue has been a shift in what shoppers purchase. The average GP% has fallen to 29%.
Here is what an average month looks like. This example does not allow for retail peaks and troughs, like winter. Revenue: $47,500. GP: $13,775. Rent: $8,000. Wages: $5,000 with hours significantly cut. Overheads: $2,800 with all possible cuts made. The business is in the hole for $2,025 a month. However, in the rent number in this example, I have not factored that half of the reduction, $4,000 is deferred, not waived. This makes the hole worse.
The owners are at maximum borrowings. They have no fixed assets against which to borrow.
The question the owners have is – do we continue to trade and lose $2,025 a month plus the $4,000 a month deferral and in six months and be at least $36,150 worse off? … knowing that realistically, the loss will be closer to $80,000 based on the current trajectory.
Talking to the owners their position is the government regulations on social distancing are what have stopped people shopping. They created the situation where our business is now no longer viable. While we support what they have done, they have left us with a financial obligation that we are considering not accepting. We think going into administration now is the best option for us, to not extend our personal exposure.
This scenario is not uncommon. It demonstrates the inadequacy of the SME retail tenancy code of conduct.
I accept it is a complex issue to address. I think that state and federal governments need to immediately agree to themselves fund 100% of occupancy costs, rent, outgoings, marketing, for 3 months from April, with a goal of a better plan being developed prior to the end of June.
That move would keep landlords and retail businesses afloat. The downstream benefit would be cash in the economy, people in jobs, fewer businesses collapsing and, I suspect, lives saved.
Note: this example is not one of my businesses and is not a newsXpress business.
I don’t believe you can save businesses that were already drowning in debt before the pandemic. Ultra low interest rates have propped up business models that would otherwise have collapsed long ago. Shopping centres have grown large on the back of this debt, a black swan event like Covid 19 brings it all crashing down. Money printing and ultra low rates by governments around the world has kept “kicking the can down the road” leaving businesses and individuals heavily indebted and vulnerable. Conveniently they will blame Coronavirus for the carnage, but their policy settings have made this much worse.
Mark,
Does your example fully allow for job keeper allowance. By fully utilising the scheme most businesses can run reduced hours are zero salary cost.it might cause individuals some pain but the scheme does give opportunity to keep going in short term.
Colin, in the example, reduced wages is for 2 owners working in the business only. The JobKeeper money flows to the casuals not getting hours. So, you could say that the business is better off for the owner salaries @ $3,000 per fortnight. It’s a benefit but not a fix.
Peter, overall I agree. I think, thought, that is a separate topic. COVID-19 will declutter retail around the world. Here in Australia, we need whole centres to be bulldozed as we are over retailed.
The problem is the recession after this, they can provide life support for businesses during social distancing restrictions but it has to end eventually. A lot of businesses aren’t going to see out the year, subsidies and such are actually going to make things worse for some in the long run. They’ll try to do the right thing by employees and believe everything will return to pre-covid, so use the subsidy, borrow money, rack up deferred rent, work their guts out only to be in a worse position than they currently are.
Governments should introduce no fault lease and franchise terminations for any small business that derives the majority of income from retail, hospitality or tourism sectors. Give the option to just pay what they owed up till time of termination, take anything that is not a fixed item or franchisor’s and walk away. It also gives the tenant real bargaining power if they want to re-negotiate the contracts. Now is a good time for restructuring or exiting from businesses. Let those businesses chose now, instead of having contract obligations force them to struggle and delay the inevitable.
PJ I agree with your suggestion.
Peter, PJ,and Mark,
All excellent comments and very true of the retail occupancy problems especially Shopping Mall rents in Australia.
Using the figures supplied the retailer is paying:
48.55% of their Occupancy cost (Rent etc) of the Gross Profit earned.
36.16% of the G.P. in Wages.
10.62% in all other expenses. leaving;
4.68% Owners Return.
This break up says it all.
It means the Landlord gets half of the Earnings of the business.
Mark, I don’t know the sq. metres occupied and I am not sure whether the business has Lotto or not
but from the figures I am assuming it has not.
Point is Landlords make money on teir return per square metre of letting space.
Retailers need to apply the same formulae or they are not in the race.
Maybe a smaller space would help, tough knowing landlords in Centres that will give you a samller space then up the ante per sq. mtr. making cheaper overall however still lessening the performnce model.
I have to agree with comments made that this is not a COVID 19 issue and it has accelerated the problem as Peter,made about the can kicking down the road since the GFC. P.J. about restructuring is also very valid today.
One of the major problems is these business were P/E ratio driven with a nett that included the owner’s wage. It was so because of the protected Block System. Many sellers still want this package to be purchased today. Banks don’t look at it that way. I am sure you know this and it doesn’t help those in trouble however if they know that they are only getting 4.68% return not including their own salary then they have no funds to carry cash flow when it’s needed be it for magazine oversupply or winter versus summer let alone a Black Swan event such as COVID 19.
This would be a great time as P.J. suggests to restructure our business model to suit.
P.S. I mentioned Lotto because it is a very import part of Centre Managements focus when negotiating leases. If one doesn’t have it they don’t show the same interest.
Yes a tough decision here Mark and I suggest one faced by many retailers in the shopping centre space. Whilst JobKeeper will help plug the hole in your example it will not leave too much left over for the owners living expenses. Remember they will also receive a minimum $20k cash boost through the ATO which should also assist. If in NSW the $10k small business grant would also be available to assist with the rent & other fixed overheads. I would also be talking to the bank re some temporary funding to pay wages until the JobKeeper subsidies are received in May.
Having said that I would go in hard on the landlord. Shopping centres in this country are going to be devastated if these landlords fail to come to the party!
Landlords live blinded to the reality of life. They believe their premises are wonderful, sought after and a bargain. They believe the tenants is lucky and should be ever grateful to the landlord.
The tenant has a different view. It is not the premises that impress. It is the footfall, demographic and spending power of those passing that interest him.
When covid19 results in no customers. It is the tenant who is entitled to question “what am I paying rent for”.
When a shopping centre is empty, it is the landlord that has failed the contract. It is the landlord who should forfeit rent.
No lotteries Graeme.
I agree with comments here. Landlords are in for a shock I suspect. It is clear to me that they are working together in a process of minimising compensation for tenants, thereby pushing more retailers over the edge.
Fashion and food will be first to collapse I suspect.
3 months rent free buys time for more meaningful discussion.
Mark,
Under the circumstances of a profitable business where the Landlord takes up to and some times more than 50% of the Gross Profit I believe there should be a rental moritorium until it is sorted. whether it be COVIND 19 or not. COVIND should be 3 months as it is not just a landlord tennant problem it’s a National-World Wide pandemic.
A well run business should be able to place these figures before an arbiter and achieve some success, enough anyway to have an extenesion to either relocate (smaller or more appropriate located etc) or vacate without penalty as the Landlord knows they are “sending” the tennant broke. I have been dirty on this one sided situtaion for years and have attended Government enquiries (as you have) and lots of clucking and sympathy, and after the end result, in favour on the Landlord. Every time. We now have a chance to expose this for what it is under a National cause although tennacy leasing is a State based Act.these circumstances have Federal connection.
Let’s move on it with a properly proposed business model of return on per sq. metre for both Landlord and tennant.
This is why I support 3 months rent free, to provide time to properly negotiate.
I’m probably not that good with analogies. I’ll give this one a go anyway. You know when you walk into a Casino and see all the bling and extravagance on show, it doesn’t take a smart person long to realise that all that’s on show is the result of a whole lot of “losers”. I always get the same feeling when I walk the corridors of major shopping centres. CEO’s earning massive salaries and bonus’s, all predicated on exploiting the best possible deals with tenants and maximising shareholder return. When one retailer fails there is another gullible and desperate “loser” ready to sign on the dotted line. Throw in the horrible franchising sector on top of this and it’s quite depressing. I hope this Covid 19 forces the shake up of all these business models. The landlord/tenant relationship should be founded on a mutual desire for success for both parties.
Peter, you’re right the analogy isn’t quite right for there are a lot of winners and could be winners that once signed are committed then upon renewal are stuffed with no where to go,but I do get the gist and totally agree with your thought re mutual desire for success etc.
Mark’s point of the three months needed for proper negotiation is important. Lnadlords have a deliberate purpose in giving the tennant the minimum time to re negotiate the lease.