Hong Kong’s notoriously landlord-friendly leases make it hard to renegotiate terms during an economic downturn, tying many tenants into leases well above market values. The territory’s high rents, added to 24 months of declining retail sales, have left retailers in Hong Kong feeling the chill. Many tenants may wish to look beyond their contractual rights and obligations to find a commercial solution. In such difficult circumstances, there are six options retailers could consider.
1. Rent restructure
Landlords are well aware of the tough retail market conditions facing their tenants and may be open to discussions of the terms of a lease, as they are likely to prefer keeping a reputable tenant for a lesser rent over being left with an empty store. Before approaching the landlord, though, tenants must have a strong understanding of their lease terms and their restructuring proposals, using corroborating data about current rents and market conditions to strengthen their position.
A tenant who believes the long-term outlook of the retail market is positive may negotiate for lower rent with increases when the market has recovered. An alternative is to trade a lower rent for a longer lease term.
2. Assignment or subletting
A tenant may also propose assigning or subletting the lease, either in whole or in part. Retail leases generally do not allow this, and landlords will be reluctant to accept lower income or a lesser tenant. This option, therefore, depends on careful negotiation and the good performance of any proposed alternative tenant.
Relocating also depends upon the willingness of the landlord to cooperate, as well as the availability of alternative premises. The landlord may be keen to keep the tenant, even if this involves relocation that gives the tenant the chance to “right size” in a proper (and cheaper) location.
4. Buyout / surrender
Tenants may also offer the landlord a buyout to terminate the lease early. Factors such as additional leases with the same landlord can be used as leverage, as well as the likelihood of any future deals with the landlord.
5. Goind dark
Most leases require tenants to keep their premises open during specified business hours throughout the year, but tenants may propose “going dark” − closing the store but continuing to pay rent. This would result in substantial savings for the tenant through reduced running costs while maintaining income for the landlord. Another strategy involves partial surrenders, and therefore reduced rent, including using less space by boarding up part of the shop.
6. Default and bankruptcy
In extreme cases, a tenant may choose to default and let the landlord claim damages. Under common law, the general position is that damages are calculated to reinstate injured parties to the position they would have enjoyed had the contract been properly performed and to compensate for any losses. Any losses claimed must have been mitigated as far as possible, and the court will take mitigation into account when assessing damages.
Some retailers establish multiple entities so each particular store is separated from all other assets and liabilities. This gives them the option to let any one particular tenant go bankrupt if need be, giving the landlord no viable means of securing rent. But unless this type of structuring was set up prior to entering into the lease, the landlord may be able to sue the tenant’s parent company to claw back losses under certain circumstances. This option is also not viable if the lease is guaranteed by either a parent company or any other affiliate of substance. There are, of course, also potential reputational ramifications in choosing this route.
Riding out the storm
Several big-brand retailers have recently been successful in renegotiating their rents. A large jewellery retailer closed part of one of its stores on the understanding it would open an extra store at another of that landlord’s properties. Coach and Tag Heuer closed flagship stores in 2015, and Abercrombie & Fitch shut its store in the Central district earlier this year. Burberry, Chow Tai Fook, Gucci, Kering and Prada have also looked to renegotiate their rents, according to media reports.
While examples of successful negotiations are encouraging, tenants should be aware that landlords may not accept an economic downturn as justification if adverse conditions were already apparent when the lease was signed – for instance, within the past two years.
The big thaw
The continued depreciation of the Chinese yuan means the years of frenzied shopping by Mainland tourists look unlikely to return. Hong Kong, however, has retained its appeal to cross-border retailers, with 73 international brands entering the market in 2015.
There are signs of recovery, too. Monthly retail sales ended their two-year slide in March, rising for the first time since February 2015. After a few stormy years, the silver lining is a more balanced retail landscape and a more diverse retail offering, as lower rents make prime shopping areas accessible once again to local retailers, fast-fashion brands and lifestyle stores.