Working out Leases and Loans
The speed at which the economy stopped in 2020 put tremendous strain on landlord and tenant relationships. The Government’s actions to intentionally stop the economy to slow the spread of COVID 19 have closed or otherwise harmed many successful businesses. Tenants and landlords are both at risk from the economic impact. Property owners and lenders may feel similar tension. This discussion can be applied in both contexts, landlord/tenant and lender/owner.
Landlords and tenants may seem to be at odds, but their interests are more aligned than is readily apparent. When a landlord receives notice of a tenant in distress, at least six options can be considered:
We recommend evaluating each situation and identifying the best solution based on the unique circumstances. Recognize that with any of these options there are laws and contracts in place that may impact the decision making process. The context for discussing these options is commercial real estate, but the principles can be applied to residential scenarios with appropriate deference to applicable law and regulation.
Option 1: Do Nothing
If a tenant requests relief, the landlord is not obligated to grant the relief. Although there may be legitimate reasons for the tenant’s distress, the landlord is not operating the tenant’s business and is not obligated participate in the downside. The tenant isn’t paying additional rent when it is business is exceptionally good, why should the landlord reduce the rent when the tenant’s business is exceptionally bad?
Landlords may offer many reasons for not participating. Any of them may be legitimate from the landlord’s standpoint. One of the most common reasons to say no a request is to simply postpone making a decision. By not agreeing, the landlord preserves the option to make a decision later according to the terms of the lease agreement.
Tenants are not helpless in this situation. They have the option of simply not paying and forcing the landlord to enforce the terms of the lease or come to the negotiating table.
Option 2: Waive All or Partial Rent
If Option 1 is extraordinarily landlord friendly, Option 2 is extraordinarily tenant friendly. If a tenant requests relief, the landlord may grant it. From the landlord’s perspective, it may be much less expensive to waive rent than have the property go vacant, pay leasing commissions and tenant improvements to accommodate a new tenant. In a commercial application, vacancy, leasing fees, concessions, and tenant improvements can easily cost six months of rental income. In a residential context, vacancy and turnover cost may equal one or two months rent. A landlord may determine working with an existing tenant may be less expensive than finding a new one.
Tenants who make a request to waive rent should be understanding of the landlord’s situation. The building owner will also have expenses and obligations to meet and asking for a waiver of rent may create a hardship for the landlord. Tenants should understand that concessions granted by the landlord are not free to offer.
Option 3: Extend the Lease Term
The end of the lease agreement may present a negotiation. Sometimes the tenant willingly vacates. Sometimes the landlord choses not to offer an extension to the tenant. Frequently, the landlord prefers for the tenant to remain in place. In these cases, a temporary lease accommodation, such as a period of free rent, may be acceptable to a landlord in exchange for an extension of the lease.
The lease extension could be for the amount of time the lease was waived, or for any other agreed upon period of time, longer or shorter. Negotiating for a longer term would be most common. On the other hand, a landlord who wants to change tenants might negotiate to shorten the term of the lease.
Tenants should recognize that the larger the concession, the more the landlord will expect. Modifying lease terms to be longer (or shorter) may be worth the short-term financial flexibility needed.
Option 4: Make Up Payments Over Time
A tenant who needs short term relief may be able to make up the rent payment over time. It could be deferred for a short period of time, or it could be spread over all future lease payments—possibly with interest. This is referred to as capitalizing the rent. In this way, the tenant receives the accommodation requested and the landlord receives the rent earned—possibly with interest for having the payment postponed. While the timing is different than originally agreed in the lease, it is a solution that can be effective for both parties.
Tenants who have a good business and who will legitimately be back in business soon expect to be able to pay a little more in the future and should be prepared to make the landlord whole over time.
Option 5: Use the Security Deposit
Many lease agreements have a security deposit. It is common for that deposit to be one or two months rent. A tenant who has a security deposit in place may ask the landlord to accept the security deposit in lieu of making a rent payment. This ensures the landlord has the lease income needed and the tenant can skip a payment to support their business.
Tenants should understand that they will not receive their security deposit back at the end of the lease term. Further, they should be considerate of the way the space is returned to the landlord so that the landlord is not penalized for having forgone the security deposit at the tenant’s request.
Option 6: Improve the Credit Quality
A tenant may not have signed a corporate or personal guarantee. The tenant may have not pledged any collateral at the time of lease signing. Generally, landlords prefer stronger credit tenants to weak ones. With this assumption, a request from a tenant accompanied by an improvement in the credit may be favorably received by a landlord.
Tenants often negotiate to minimize long-term credit exposure. A tenant who wants the landlord to support its long term business opportunity can lower the risk of default to the landlord. A request to waive rent and simultaneously reduce tenant credit exposure could be seen as a sign of a tenant’s weakness and incentivize the landlord to find another tenant to lease the space.
There are many options available to both landlords and tenants facing difficult times. Any of the solutions could be appropriate depending on the circumstances. In considering these options, it is important to make sure than any adjustment is compliant with agreed upon covenants and in accordance with government regulations and directives, which differ for residential versus commercial property. Finally, it is critically important that whatever decision is made, document the revised terms in writing signed by the parties as an amendment to the agreement. Landlords and tenants can obtain better results as they work together.
NAI Excel, NAI Vegas, and its affiliates manage over $350 million in real estate assets from Salt Lake to Las Vegas and are available to assist in managing Landlord and Tenant relations.