These are troubled times. The COVID pandemic is crushing some segments of the commercial real estate industry, including particularly retail and restaurants.
In COVID-19 lease negotiations, I usually represent commercial landlords. When representing commercial tenants, knowing the challenges landlords face is useful. Commercial tenants should recognize that when seeking rental abatements, or other rent relief, they are proposing to shift the financial burden of COVID from tenant to the landlord. Landlords may want to help; but they may be unable to do so and preserve ownership of their property.
The good news is, there appears to be light at the end of the COVID tunnel. Vaccines are here. The bad news is, we have a long recovery ahead for small businesses and commercial landlords.
The idea that most commercial landlords are “rich people”, large corporations, or REITS who can better weather the financial storm brought by COVID is not true. Most landlords rely on timely payment of rent to pay their mortgages and other expenses of ownership. And, unlike commercial tenants, landlords did not receive direct relief under the federal CARES Act. The forgivable PPP loans to small businesses allow commercial tenants to use up to 40% of the loan proceeds to pay rent. This was designed to help small businesses survive, and to indirectly help commercial landlords by giving commercial tenants funds to help pay rent. Frequently, commercial tenants have ignored this aspect of the PPP loan program.
Strategically, tenants make a mistake when they approach their landlord with a sense of entitlement, and demand rent relief. COVID-19 is not the fault of the landlord any more than it is the fault of the tenant. At a minimum, when asking the landlord for rent relief, a commercial tenant should be prepared to certify to landlord that tenant has suspended distributions to tenant’s owners and investors. The landlord is not the tenant’s business partner. Why should a landlord take a financial hit to enable a tenant to continue to pay tenant’s owners and investors? Landlords have their own financial challenges.
Except in rare occasions where the lease terms provide otherwise, commercial tenants are not automatically “entitled” to rent relief because of COVID-19. It is not a right. If a commercial tenant needs COVID rent relief, it must be willing to be financially transparent and able to make a compelling case to landlord as to how the landlord will benefit by granting the requested relief. Even a compelling case may not be enough if landlord’s mortgage payments, real estate taxes, insurance, utilities, and necessary third-party vendor obligations cannot be paid or abated. Tenants need to provide information to landlord to enable the landlord to likewise make a compelling case to its lender and critical third-party vendors.
Plausible workout strategies may include:
(a) temporary deferral of monthly base rent to be repaid later, with or without interest; or
(b) temporary abatement of monthly base rent in exchange for an extension of the current lease term.
Abatement is a forgiveness of rent. Deferral merely postpones the due date. A landlord will typically need corresponding relief from its lender to help fund the abatement or deferral, and to suspend applicable loan covenants.
Often the best solution is a partial rent abatement (say, for example, a 25% to 50% base rent abatement for a short period) in exchange for extending the term of the lease at full rent. This helps give commercial tenants the rent relief they need in these difficult times, while preserving the value of the property for the landlord – and collateral value for its lender.
Finding a solution that preserves the tenant as a viable occupant and preserves the value of the property for the landlord and its lender is the surest route to avoiding costly and catastrophic litigation.
Thanks for listening,
Kymn
