Despite mixed messages over the past few weeks, it sounds as if the Bank of England is considering taking UK base rate interest below 0% in order to give itself and the Chancellor more headroom for measures intended to restart the economy, and then keep it going, as we start slowly to come out of lockdown and other fiscal measures, such as the furloughing scheme and government-backed loans for small businesses, come to an end. The general economic consensus is that for various reasons like Brexit, global recession, semi-permanently low oil prices, the need to over spend to “level–up” inflation will be almost non-existent and although the government will need and is willing to borrow its way through this, bond rates will remain low to zero and below. If we do see UK base rate going below zero then what would that mean for real estate contracts?
Most commercial leases and other real estate contracts will contain provisions referring to base rate interest, and very few of them will anticipate negative interest rates. For instance, a tenant must usually pay interest at base rate on any “back-rent” after a rent review has been settled. If the interest rate is negative then might the landlord have to pay the interest to the tenant? That could be the outcome if the drafting required the back-rent to be paid “together with base rate interest” and if so, then the result would be a reduced back-rent payment to the landlord.
Do provisions that prevent tenants from making deductions or setting off monies from payments help here? Probably not. Strictly speaking, this is not the tenant making a deduction or exercising a right of set-off, it is a direct result of the lease drafting, and so the parties are simply doing the maths and making the payment due under the lease.
Unless negative interest rates plummet, penal rates for late completion of a purchase, or a late rent payment, would probably be unaffected as they are usually two, three or four percentage points above base rate. But if the negative base rate is low enough, it might mean that the landlord has to pay the tenant for late payment of rent, or the seller has to pay the buyer for late completion! That would be surreal!
What would happen to interest on rent and purchase deposits? Can a deposit taker comply with an obligation to place it in an interest bearing account if the interest rate is negative?
There is an easy drafting fix for this, and we did see it drafted into some documents around 2016 when we last thought that interest rates might go below zero. If you provide that, where the base rate is negative, a zero rate applies, then the issues described above should vanish. Another potential solution is to agree a fixed rate, as long as the rate you choose is not out of line with the market and therefore could be seen as a penalty.
But would you actually want a fix at all? If negative interest rates reflect a topsy turvy economic paradigm where having cash in the bank costs you money, wouldn’t you want to minimise cash receipts (for a while at least) and therefore actually prefer to receive payments late, or lower amounts (as long as your fixed costs are covered)? Certainly economic theory suggests that if stagflation is a semi-permanent state then you are ok with receiving less than zero – that sounds exactly what bond buyers at negative rates expect/want as they assume other assets will depreciate further so this is a hedge against what might happen if they deploy capital elsewhere – I know, I am not an economist so that seems weird to me too!
Would there be any difference at rent review between a lease containing a provision collaring base rate interest at 0% and another lease without it? Would a rent review surveyor treat differently a lease that is out of keeping with the rest of the market in this way? Even since 2016, normal commercial leases have not typically contained this sort of provision; it is not in the Model Commercial Lease, for instance, and why would it be? Would landlords want a drafting fix if it might unintentionally be seen as having a negative impact on rent review?
A drafting fix won’t help with existing leases anyway, as it isn’t practical to try to vary them all. They will therefore need to be re-interpreted in the context of negative interest rates. For that you would need either legislation (which is unlikely), guidance from the courts (which you might, possibly, get in time, especially as the indications currently are that the Bank of England isn’t ready to take base rate interest below zero just yet), or just a commercial approach recognised by the market (which in reality is probably the most likely solution).
If asked to consider a lease in this context, a judge might decide that the draftsman did not have negative interest rates in mind when preparing a lease, and rule that a tenant who pays late should not benefit from his breach by being entitled to deduct (ie apply negative) late payment interest from, and so reduce, his payment to the landlord. On the other hand, he might decide to uphold the strict wording of the lease! It wouldn’t be the first time the courts decided that our commercial assumptions were wrong.
Might commercial real estate investors just live with the outcomes? At first glance they seem unattractive, but businesses would evolve in their approach in an environment with negative interest rates. If it will cost money to have cash in the bank, because the bank is charging (not paying) interest, businesses will re-assess their cash flow and investment needs and could refocus their investments to capital appreciation and low/no yielding assets. They might decide to pay for things in advance (if they can find someone to accept the early payment). Conversely, they might want to receive payments as late as possible and be unwilling to accept pre-payments.
There are lots of questions to which, as yet, there are few answers. But if the Bank of England does take the plunge, and makes a negative UK base rate a reality, we will need (quickly) to ask and answer these questions.