Before You Break That Lease Over COVID-19, Negotiate First, Brokers Say
The temporary shutdown of businesses nationwide due to COVID-19 prompted commercial real estate tenants to search their leases and insurance contracts, looking for ways to break up with their landlords in the event of financial hardship.
When the rent comes due April 1, either side of the deal may be tempted to play hardball to shore up its company's financial position. But experts who survived the last recession say a lease modification strategy — while never a sure thing — is better than running a scorched earth campaign between tenants and landlords.
These conversations should take place before tenants breach a lease or abandon a property outright.
“You have to remember, we work with attorneys and there are a lot of great attorneys out there,” Whitebox Real Estate co-founder and President Grant Pruitt said. “But real estate brokers don’t get paid by the hour. They get paid by coming up with solutions, and so the concern is if you hire a litigator, you are going to get a huge bill regardless of what happens. You may not have a successful resolution, but you are still going to have a huge legal fee. That is why you really want a good tenant rep.”
This flexibility is more important than ever with courts in New York and other U.S. jurisdictions freezing local evictions altogether and refusing to hear nonemergency matters during the pandemic.
“People have to look at alternatives because the court avenue just doesn’t exist now in New York,” Rosenberg & Estis managing member Luise Barrack said.
Barrack, who represents lenders and landlords, said in her experience, a congenial approach can pay off in times like these, as landlords and tenants are incentivized to preserve their existing business relationships and lease agreements.
Real estate brokers and lawyers spent the past two weeks fielding calls from landlords and tenants who are trying to make leases work with no traffic coming in and the economy in unprecedented turmoil.
“We are seeing a growing number of small-to-midsized businesses becoming confused and afraid ... and [they're] trying to figure out how they are going to stay in business,” ARVO Realty Advisors President and CEO Ed Ryland said.
“Some of the strategies may be an outright forgiveness of rent, maybe some modification or restructuring of the lease agreement … or maybe a partial facility lease abatement,” Ryland said.
Barrack said her landlord clients have agreed to adjust rents when they are legally and financially permitted to do so. When a lender's involvement is required for a landlord to change a lease, building owners are reaching out to banks to see what's financially possible, she said.
“Most folks who are business-minded are trying to get through this as best they can and are hoping that they can get through it with their tenants in place on the other side of this,” Barrack said of landlords. “And if they have to defer some rent, that’s what they’ve been doing.”
Landlords are showing signs of wanting to keep their own tenants afloat for as long as possible, ARVO Realty's Tiffany Ryland said.
“We have had landlords reach out and ask us how they can be of assistance to their tenants,” she said. “They understand the option is to lose a tenant entirely, or they can figure out some way where they can offset the cost and keep the tenant as well.”
Pruitt with WhiteBox said landlords need to show their own lenders strong occupancy numbers throughout the life of a loan and consistent cash flow, and these two things could prompt landlords and lenders to ease up on tenants for a short period of time as the market adjusts.
“We can work with [the landlords] to extend the [lease] term,” he said. “We can ask for a rent abatement, rent reduction, whatever we need upfront, and then, we can stair-step it or balloon [payment] it on the backside to extend it further out,” Pruitt said.
Asking a landlord to simply give a rent holiday or allow for abatements is not as cut and dried as it sounds, particularly if a lender is involved.
Landlords like Boxer Property CEO Andrew Segal worry landlords who adjust existing agreements to help tenants survive may find themselves inadequately funded as they try to pay their own mortgages, on-site security, staffing and taxes.
“We have people who are on the other side of these payments,” Segal said. “And in my mind, it is not an option for the landlord to stop making those payments; therefore, the rent has to be paid.”
The only time an alternative solution might work is when a tenant's lease is about to expire, Segal said.
“I think to the extent that a tenant’s lease is about to come up, it’s legitimate to roll it into an extension, but to the extent the lease is not up, I think there is a circle of survival,” he added.
Segal and other landlord representatives also worry about tenants taking advantage of the economic crunch to break leases they can afford to pay.
“The problem from the landlord’s point of view is we don’t know who can’t pay the rent or who can. I am not even sure they know,” he said.
Davis|Kuelthau attorneys Mike Van Someren and Ethan Geis agree landlords need to be careful in how they modify leases, but said it is possible with due diligence.
“I think one of the things everybody needs to be doing is making decisions with good solid evidence," Geis said.
“I think it's fair for a landlord to start asking for financial statements, and to say, 'Look, before I enter into any negotiations with you or sign up a short-term lease amendment, I need to actually see your financials to make sure you are not trying to pull one on me.'”
Even though landlords and their lenders need to make thoughtful decisions, both Geis and Van Someren see a need for cooperation whenever possible in today's crisis.
“We have a lot of retail clients, the landlords especially,” Van Someren said. “We [started] getting calls almost immediately because certain brick-and-mortar retail has already been struggling, and now you hit them with this stay away order and it has been very difficult for some of them.”
Geis said that with courts not taking evictions and the market in turmoil, he is advising landlords to consider alternative solutions whenever possible.
“I think a lot of [landlords] are hesitant to immediately give a rent holiday,” Geis said. “Some of the advice we have been giving out is look ... I think you are going to have to play ball here, because if you start defaulting tenants and going through the eviction processes, you are going to have a world of headache both from social pressure and also there is going to be some legal arguments with force majeure.”
Brokers involved in restructuring leases also believe tenants who choose to stay and work things out with their landlords could find a silver lining in the midst of market disruption.
“There was a deal that I did during the [last] recession where the [client] was in 30K SF and expanded it to 60K SF,” Pruitt said. “We reduced their rental expense for maybe the first two years, and we stepped it up on the backside.”
After the tenant renegotiated the deal, the landlord walked away with space filled and promised rent for a longer time period. Meanwhile, the tenant doubled its square footage and reduced its rent.
“My advice is to try and work something out,” Pruitt said. “I don’t ever advise a tenant to break a lease. It is a legally binding agreement. There are a bunch of different ways you can handle this.”