A SIGNIFICANT shift is occurring in business management.
After more than two years of the deepening recession, boards and CEOs have gone beyond fixing their profit and loss account and are now addressing their balance sheet. Cost-cutting of payroll and other expenses has been exhausted.
The opportunity to increase gross profit or trading margins does not exist. The decline in turnover is continuing unabated throughout 2010. Trying to fix on a budget is akin to catching a falling knife. The culmination of these factors has meant that trading out of trouble isn’t sustainable.
Previous business models are no longer workable. The average decline of revenue by one-third has resulted in an acceptance of structural change. What’s happening in AIB (ie, the sale of Polish and American profitable assets to clear debts) will be replicated across a range of enterprises.
Most businesses don’t have recourse to NAMA to expunge toxic debts. The prospect of consolidation, through mergers and acquisitions, is accompanied with rationalisation of loss making units. Past paradigms have to be discarded. Nowhere is this more evident than in the retail sector.
Around 35,000 retail employees have lost their jobs since early 2009. As many as one in five of all retail outlets will close. The high street is littered with auctioneers’ signage ‘To Let’ or ‘For Sale’. Boutiques, bookshops, jewellers, chemists, butchers, travel agents, newsagents, coffee outlets, delis and convenience shops are all turning the key and shutting.
Even bargain-hunters can understand that pre-Christmas sales and 70% discount offers are not viable in the medium term. An excess of stores is the outcome of a 20% contraction of the domestic economy. Overcapacity threatens another 30,000 jobs.
Decline in demand is only a partial reason for business closure. The damage done by the property bubble has been well documented in the context of the banking crisis. Another less known toxic component relates to the impact of the property burst on the retail sector. Most high street businesses do not own their own freehold. It is tax-efficient and cashflow-positive to operate long-term leases. Our landlord and tenant legislation entitles occupants to a long-term lease, almost in perpetuity, if their existing terms exceed five years.
Entrepreneurs prefer to tie up their money in stocks and shop fittings rather than bricks and mortar.
A cancer pervades the retail environment. It is the legal inflexibility of our leases to respond to the property crash. Put simply, commercial property has on balance declined by 50% in value. Depending on location, the impairment can vary. Shop units and overhead office accommodation is in surplus supply. Main thoroughfares were extended.
New town centres and retail parks were constructed on the assumption of an unending exploding demand for an enlarged shopping experience. Town planners and property developers got their projections woefully wrong. Throughout every provincial town, side streets are closing down, with a consequent migration on to main streets.
The kernel of the problem is that landlords, especially the corporates, are refusing to accept market reality by insisting on zero rent reductions. This can be in stark contrast with the understanding showed by individual property owners who appreciate their tenants. Because the courts entirely validate existing leases, landlords can rely on a ‘not an inch’ negotiating stance. This implacable approach denies commercial renegotiation of rental terms. When arrears are amassed they simply proceed to the courts to obtain judgments for outstanding sums. This routine gives a preferred creditor status to property-owners, although often unsecured.
This farce has no commercial logic. The consequences are that retailers are incentivised to self-destruct their businesses in order to escape the stranglehold of these leases. If they were to start again in an adjacent unit, they would do so with a rent holiday and a fraction of rental costs.
A number of high-profile cases of examinership have resulted in the examiner negotiating new ‘Vanilla’ leases and discarding previous arrangements. Xtravision, O’Brien Sandwich Bars, Chartbusters and pub chains have all been subject to this metamorphosis – wiping out shareholders.
Politicians and judges seem oblivious to the zombie condition of many retailers. Government has been lobbied by retailers to abolish upward-only rent review clauses on historical leases. Excuses, such as the constitutional protection of property rights, have been advanced for inaction.
A working group on transparency in commercial rent reviews has failed to deliver reform. The deep irony is that the worst offenders are the largest property consortiums. Taxpayers are underwriting NAMA, which will become the largest property vehicle in the state. NAMA will become a mega vested interest in this unequal struggle between landlords and tenants. Property values can fall to the floor, but rents can only rise. This shambles is a travesty. The biggest sufferers will be the displaced staff at the checkout counters.
A two-tier system of leases is now emerging. On one hand, legacy leaseholders have to endure Celtic Tiger rents that are unaffordable, whereas new leaseholders can access revised costings based on market adjustments. The financial and legal muscle of the state stands against the faltering retailer. Tenants are threatened with two-and-a-half years rent costs in order to exit from a closed entity. No other sector has been afforded the same court protection, as cost structures have been dismantled. These same property-owners appear ignorant of wider consumer trends.
IRRESPECTIVE of the recession, the internet is creating revolutionary changes in shopping patterns. The high street travel agent is being replaced by Google search and online sales. The music shop is being made redundant by CD downloads. Bookshops are being supplanted by sites such as Amazon. Elsewhere, drink sales through pubs are being directly replaced through off-sales. The emerging trend is universal. Customers are altering their shopping habits – migrating away from the high street.
The costs of doing business on the high street are proving prohibitive. Finance for local government is being sought through commercial rates. The revenue base has narrowed. Domestic household rates and water charges were abolished. The valuation system, the base for rates liability, is unable to comprehend recessionary realities. Both rents and rates need to take account of the transparent decline in turnover levels. Pro-rata reductions represent an equitable approach. Landlords in Dundrum Shopping Centre are seeking a 70% increase in rent from retailers who have suffered a 35% decline in sales.
This madness cannot continue. The destruction of retail enterprises, due to intransigent lease law, has an extremely detrimental impact on unsecured trade creditors. These suppliers of stocks and services are at the end of the creditors’ queue. Durable economic regeneration requires more than a bank and developer bailout. Failure to address the retail tenancy crisis will paralyse many otherwise viable businesses. The scars on our retail landscape will be permanent unless new economic realities can infuse the imbalance in property rights.
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