Property owners have received thousands of notices that their commercial tenants can’t or won’t pay rent and, in many cases, want a rent holiday for up to four months. Most of those notices still receive no response, a “wait and see” response, or a hard-line response that the tenant must pay its rent. Some owners and tenants, though, are starting to negotiate deals.
Owners typically don’t agree that a pandemic and massive shutdown automatically justify up to four months of free rent. As in any other business transaction, they start by asking questions like these:
- Exactly how is the pandemic causing financial hardship for your business?
- Please provide current financial reports demonstrating that impact.
- What government assistance or insurance coverage have you obtained or are you seeking?
- How many employees have you kept, laid off, or furloughed?
- What is your exposure on other leases? What arrangements have you made there?
- Please provide current financials for tenant and its principals, including any guarantors.
- Although this location is presently shut, how has it performed for you over the years? Please provide sales reports or location-specific profit and loss statements.
The preceding information will help the owner determine its approach. The situation also creates a game of chicken. If the tenant simply leaves and doesn’t come back, how will that play out for the owner? But if the owner accommodates the tenant today, does that, in fact, reduce the risk of losing the tenant, or just defer it?
If the owner wants to keep the tenant, but the tenant is truly up against a wall and neither the tenant nor its guarantor has resources to pay rent, an owner might make a deal. Any rent holiday won’t cover more than a month at a time, maybe two.
Owners would prefer a rent deferral. Smart tenants know that a deferral just defers a problem without solving it. A very long deferral might work, though. If a tenant has a substantial security deposit, the parties might agree to apply some of it to pay current rent, with the tenant agreeing to restore it later, perhaps much later – a variation on the deferral theme.
The owner might forgive or defer only part of the tenant’s rent, not all of it. And a smart owner will structure any deferral or forgiveness so it goes away if the tenant later defaults.
Some suggest that the tenant should pay only enough to cover the owner’s debt service, taxes, and operating expenses. The owner would suck it up and forgo profit during the pandemic. In the real world, though, especially in New York City, an owner needs most of its revenue just to stay above water.
As another possibility, maybe the tenant should agree to pay the deferred rent only if the location later becomes very successful, or the tenant should agree to pay percentage rent. For smaller tenants, though – the ones that need relief most – an owner won’t have much confidence in financial reporting and hence will have little interest in any form of hope certificate.
The owner might still want financial updates going forward. Traditionally, at least outside of malls, a tenant’s sales and profitability were none of the owner’s business. Now that owners have unexpectedly and involuntarily become participants in the downside of their tenants’ businesses, perhaps it’s reasonable for them to at least know how their tenants are doing going forward, even if the numbers are not reliable.
An owner might reasonably ask the tenant to make some other concessions. The tenant might prepay at least some of any reduced rent. If the tenant pays real estate taxes, the owner might particularly insist on an early deposit of funds. Perhaps the lease should be extended for the duration of any rent holiday, or the owner should obtain a termination right. If the lease has burdensome pro-tenant clauses, such as purchase options or rights of first refusal, maybe the parties should remove them. The owner should certainly obtain comfort that neither the tenant nor the guarantor has any claims or issues. Everyone should agree to confidentiality.
Before making any deal with a tenant, the owner must check its loan documents. Failure to obtain lender approval for a deal may create a default. In the worst case, it may trigger a guaranty of the loan.
For the most part, though, owners and tenants are still deer in the headlights, waiting to see what happens next.