March 30, 2020
A frequent question consistently raised during these tumultuous times is how to handle a tenant seeking to renegotiate its rent payments or cease paying rent altogether. As this post explains, it’s best for both tenant and landlord to work together to reach an amicable solution. Let’s take a look at the issue from both perspectives.
Tenants should carefully review their lease agreements to understand their rights during current circumstances, as non-essential businesses have been ordered to shut down. In particular, many leases contain a force majeure clause, which may have been perceived to be an insignificant issue at time of lease negotiation, but suddenly is gaining lots of attention. This clause is a legal term pertaining to unforeseeable circumstances that prevent someone fulfilling a contract. The advent of COVID-19 can certainly be considered an unforeseeable circumstance, but all force majeure clauses are not uniformly negotiated. These clauses may not explicitly permit a tenant to cease rent obligations, and may require tenants to continue paying rent. Sometimes this clause may not be included in a lease altogether. Further, pursuing a force majeure case can be time consuming, lead to costly legal bills, and may be difficult to wind through the legal systems. A better solution is for a tenant to approach its landlord up front to work out an amicable solution. In many cases, tenants will find a sympathetic landlord especially if the relationship has been positive leading up to the current crisis. Hopefully, the landlord that has existing debt, and in turn has a sympathetic lender that is also flexible on loan payment terms. Unlike the Great Recession, most banks have strong balance sheets heading into the current crisis, and are on more solid footing to offer flexibility. However, tenants should understand that in addition to debt obligations, landlord’s also have bills to pay such as real estate taxes and operating expenses. Further, not all lenders will be amicable to allow restructuring of landlord’s debt service, and loans may contain specific covenants requiring the landlord to maintain specific cash flow levels and other ratios.
Alternative methods to structure rent include a straight rent abatement for a period of time, partial rent abatement, rent abatement with tack on of equivalent rent on back end of the lease and a more aggressive restructuring of business terms. The latter approach, popularly described as “blend and extend” during the previous downturn, is to reduce the rentable square footage, and gradually increase this over the term and extend the lease term altogether. This allows the tenant to obtain up front relief while stabilizing the tenancy for the landlord especially if the lease is close to end of the term.
Tenants should also take a hard look at the recently signed Cares Act for beneficial provisions such as the Paycheck Protection Program which, for eligible employers, provides for a refundable credit against qualifying wages, as long as the employer continues payroll for its employees. More details on this program can be found here: https://drive.google.
Setting the scene for landlords to treat tenants amicably, the second largest apartment owner in the country, Equity Residential, recently announced that it will pause evictions for tenants that have been impacted by COVID-19, as well as hold off on rent increases for 90 days. However, commercial leases are more complex than residential leases, and most landlords are not as well capitalized as Equity Residential, and thus need to take more proactive action.
One of the first actions a Landlord should take to get out in front of this issue is to immediately reach out to its lender to find out flexibility of the terms of its loan. As mentioned previously, the current crisis is not rooted in the financial services industry. Some lenders have been considering interest only payments for a period of time. Perhaps relaxing cash flow, cash on hand and other loan covenants can be arranged.
Landlords should also carefully review their lease agreements and understand tenant’s rights under force majeure, as well as its own rights in the event of tenant default. As mentioned earlier, taking legal action can be costly, and it is highly unlikely to find a landlord-sympathetic court to hear an eviction proceeding for quite some time. Further, eviction is not prudent with the prospect of having an extended vacancy, and best to be cautious with pushing default given social pressure and potential tenant legal argument of force majeure.
Landlords do not need to be in a position to be taken advantage of and tenants should be prepared to fully explain its financial position and provide financial statements for the Landlord and Landlord’s lender to review. If a tenant’s claim is legitimate then there should be no issue with providing financials.
An experienced commercial real estate broker can be the trusted advisor for either party to find the best market based solution during these challenging times. Please contact me to review your specific lease issues and assist with navigating this complicated landscape to find the ideal solution in order for you to be successful.
Warren Brown, Boston Commercial Properties, Inc.