SURPLUS property leases are the unwanted products of mergers and acquisitions, changing business models, technological advances and more flexible, agile working practices.
Organisations just don’t need as much space as they used to so they end up with surplus warehouses, redundant offices, bank branches, or retail outlets – on leases they cannot walk away from.
Tackling this wall of surplus property is hard work – it takes committed resource, usually some cash to make the space lettable and acting fast to capture any available tenants or transactions. Sadly resources, capital and speed are the last things that occupiers commit to surplus leases. I say occupiers – but in these cases strictly speaking they’re not – the properties are vacant and the business is busy focussing on its core activities and the supporting occupied property portfolio.
The surplus lease problem is exacerbated by the requirement under International Accounting Standard IAS37 to make a provision for the costs of disposing of ‘onerous leases’. This means an unwelcome, one off hit to the income statement and a corresponding balance sheet provision.
However an answer has emerged that enables all organisations to deal with this unwanted problem – The Lease Liability Transfer (LLT). This is a product that has developed to solve the problems of surplus leases.
With an LLT organisations can transfer all of their surplus leases to a third party LLT specialist, the purchaser, who takes over responsibility for all surplus lease obligations by way of a management agreement.
In return the vendor pays a sum typically equivalent to your onerous lease provision to the LLT specialist, which is the transfer price and is paid either upfront or in instalments.
The objective of the purchaser is to dispose of the properties as quickly and cheaply as possible, beat the transfer price and generate a profit.
How can LLT specialists dispose of properties more quickly and cheaply than the occupier themselves? Well there is no dark secret – but unlike the occupier, they are able to commit the resource, capital and speed of decision making to make things happen. They find creative solutions – whether it’s buying in a freehold to sell a property on, changing property use, or sub-letting and surrendering to landlords. They relentlessly pursue the ultimate goal of an exit which avoids any further liability – meaning the property is “off risk”.
So what protection is in place for the occupier?
Well, firstly the occupier has a charge over the Special Purpose Vehicle (SPV) that is established to manage out the leases as well as a charge over the Bank account which holds all of the cash.
Secondly, the LLT specialist can only take any profit out of the vehicle when the portfolio is completely off risk for the occupier.
Thirdly, the management agreement defines what the LLT specialist can and cannot do, the waterfall of payments, reporting requirements and obligations to the occupier. The funds have got to be used to reduce the obligations under the leases.
What does the occupier get out of it? Ultimately they get out of the surplus leases more quickly and cheaply than if they had done it themselves and they can share in the upside. Typically there is a profit share mechanism in place to enable the LLT specialist to earn a reasonable return with further upside split between the parties.
A number of LLT transactions have now been managed out successfully on behalf of Wolseley, Carillion, Morrison’s and Virgin Media, More recently JLL have led the LLT disposals for over £100m of gross liabilities on behalf of Royal Mail, Santander and the Department of Business Innovation and Skills.
There are a number of LLT specialists out there keen to find more surplus lease portfolios and expand this marketplace. For occupiers it’s a win-win situation – why wouldn’t you save yourself time and money and outsource your surplus leases to the experts?
Michael Evans is director of corporate solutions UK at JLL, a financial and professional services firm specialising in real estate services and investment management.