Technology will revolutionise the commercial property sector, with far-reaching consequences for landlords, tenants and advisers.
Futurology is an art rather than a science, because you do not have the benefit of hindsight. I have taken a punt into the future for the benefit of landlords and tenants, and those who advise them. The only way to test whether I am remotely right will be to read this article in 2024 (I will accept no criticism before this date!).
With more businesses making use of the internet and migrating their bricks and mortar activities online, commercial landlords and tenants should be aware of how they structure property transactions.
The key considerations for tenants are balancing flexibility against added costs, and for landlords to ensure that their tenants are likely to stay in business. Landlords may want to think about what kind of tenants will need more commercial property space as a result of new technology, and avoid tenants who are likely to need less. Over the next 10 years, technological advances are likely to be far bigger than in the previous 10.
Cast your mind back to the use of the internet and mobile phones in 2004, and think where they have got to now and where they will be in 2024. Also, think about how this has affected landlords. For example, rock-solid covenants from video shop franchises became worth very little very quickly when online competitors arrived. Anyone signing a 10-year-plus lease either as a landlord or a tenant should be thinking about how technology will affect the use of the property and its investment value. Landlords may want to consider whether the tenant’s business in the premises is likely to be viable in five years.
Businesses at risk today are those which thought the internet was not relevant to them, or businesses which will be affected by the next round of technological advances. These may comprise: 3D virtual reality; new product delivery systems such as drones; medical-based applications; and body-scanning techniques which allow precise measurements to be taken for clothes (this article does not consider the impact of nanotechnology on commercial property, which is also likely to be profound).
As an example, 3D virtual reality is likely to change the way recruitment companies work. There will be less need for people to be interviewed in person and therefore less need for these companies to occupy commercial property. In fact, there will be a race for bigger established companies to shed property leases to stay competitive with new internet-based competitors.
Drones are being tested in the US for commercial delivery purposes. They are suited to deliveries of smaller packages which need to be made urgently. A drone could deliver a package by air, door to door, in 15 minutes across a city. The same delivery would take several hours for a van. This is likely to be a business-to-business delivery and access for drones to land on rooftops may become an issue within the next 10 years.
Medical applications are likely to happen very soon. This could allow blood pressure monitoring, blood tests and other simple medical procedures to be carried out by machines linked to the internet. The savings for national health authorities would be considerable. This may mean changes to the requirements for medical premises.
Linked to medical applications are body scanners. One of the difficulties in selling clothes over the internet is knowing customers’ sizes. A body scanner that can calculate a person’s size accurately, and then produce clothes made by computer which fit exactly, would introduce additional competition for high street retailers. This has already arrived on the high street for the purposes of measuring children’s feet for shoes, thus speeding up the selling process.
Flexible leases – break clauses
Competition from online sales can make shop leases look very expensive. It may be better for a tenant to pay more rent at the outset and negotiate break clauses to allow them to exit from the shop lease if needed. This is the current trend. If you think that an online competitor could sink your business in a short period of time, you may think that a rolling break clause is worthwhile paying for. This is a break clause which allows the tenant to go at any time, subject to, say, three-months’ notice. Conventional break clauses can only be exercised on dates specified in the lease – which may be too late.
Most leases have tight user clauses which specify the kind of activity the tenant can carry on. Take the example of a retail operation that opens up internet sales, with goods being collected at a shop which operates as a semi-warehouse. This may well contravene the user clause, unless provision for a future change of use was included in the lease when it was negotiated at the outset.
In some cases, the advent of online sales may mean that the retail unit is effectively closed and used purely as a distribution centre for buyers to collect goods. This may be a short-term measure while the lease runs out before the tenant relocates to cheaper warehouse premises.
Take the example of a body scanning machine which works out customer sizes. The retailer tenant may change its business model and have scanning machines on the premises with limited stock. Garments will be made to measure, either on the premises for immediate delivery to the customer or elsewhere to be delivered later.
Also worth a mention is the development of 3D printers. There is the possibility of consumers having goods printed for them in the shop. This is not far-fetched, as the development of 3D printers is progressing rapidly and, for example, is already used by BAE Systems to provide components for fighter jets. Is the use of a 3D printer light industrial for the purposes of the user clause, or planning?
Bricks and mortar shops may have to become ‘shopping experiences’ which involve some form of catering and entertainment. This could take the form of coffee shops, either branded or non-branded, within the retail unit or some form of live entertainment such as music or comedy. This may be a breach of the lease or require the consent of the landlord. Sub-letting or licensing part of the premises to a branded coffee shop may involve parting with possession, which is usually prohibited.
The standard retail ‘look’ of premises may need to be changed, either to a collection point or a ‘shopping experience’ unit. This will invariably involve physical changes to the unit which may require the landlord’s consent.
Another strategy is to have the bulk of online sales supplied by an out-of-town warehouse but with a flagship bricks and mortar shop on the high street where customers can ‘touch and feel’ before they buy. The high street shop can promote quality and be visually useful for marketing. Here, the alterations to the shop will differ in that the occupier would want to spend money on it to make it look more upmarket to help internet sales. The trend is likely to be for more expensively fitted shops in more expensive areas, close to other expensive shops.
Changing the use of premises may involve obtaining planning permission. Technological advances leading to pressure from retailers is likely to mean that the planning rules and how they are applied will change. This is difficult to predict but is probably an area in which there is a lot of money to be made.
New technology such as virtual reality is going to change business in much the same way as the internet quickly put most high street travel agents and insurance brokers out of business. It is difficult to know what technology is around the corner, but you can be sure that some of it will arrive soon and deliver a knock-out punch to some bricks and mortar businesses.
If the tenant is taking premises aimed at internet sales such as distribution centres, it may be sensible to take these leases in the name of a separate company, so that the internet part of the business functions separately from the bricks and mortar part. This could be helpful if it is decided in future to sell off or close down the bricks and mortar. This potentially ringfences the businesses and the leases, subject to any other security which has been given such as a cross-company guarantee.
Businesses which will need more commercial space
The businesses which are likely to expand their bricks and mortar operations are going to be involved in touching, tasting, smelling and caring. Technology is going to take a bit longer to be able to replicate these experiences. As an example, restaurants are unlikely to be affected and in fact will probably expand, because people craving a ‘shopping experience’ usually also crave a coffee and/or a pizza.
Services such as hairdressers, key cutters and dry cleaners will also always need premises. With more ‘shopping experience’ outlets, childcare is going to become more important. A mother spending money in an upmarket mall may expect children to be taken care of as part of her shopping experience.
Little thought is given to how the need and use of commercial property will change during a lease. Money can be made and lost very quickly, with technology advancing at an increasingly breakneck pace. Landlords and tenants will have to think how their investments and businesses could change and make sure they stay on the winning side.
David Anderson is a solicitor-advocate and chartered tax adviser at Sykes Anderson, London EC2; Olga Tabenko, a trainee solicitor at the firm, also contributed to this article