In addition to the pandemic changing shopping habits, the resulting unemployment has also impacted the spending power of many consumers. Additionally, many offices are being downsized as companies realize that working from home might be more feasible than they thought. The result of all these trends is a major challenge for commercial real estate owners.
We are seeing several strategies being employed by real estate owners to cope with these changes. First is the tried-and-true strategy of Blend and Extend. For commercial tenants who are unwilling or unable to make their current rental payments, landlords are often offering rent holidays or discounted rent (essentially a blended rent rate) in exchange for committing to a longer term lease. With this strategy, landlords can reduce the uncertainty of having to rent out the property sooner than expected, due to a tenant default. Additionally, the prospective cash flows from the ongoing lease give comfort to the lenders who financed mortgages on the commercial property itself.
A more novel trend we are observing is the renegotiation of leases to include a Pandemic Clause. In the past in the United States, the idea of a pandemic and its impact on foot traffic rarely came to mind when negotiating commercial leases. Not having had such a problem in their own life experience, tenants did not address it in their lease negotiations.
In today’s world, with undulating waves of shelter in place orders followed by teeming crowds in the streets, followed by more shelter in place orders, tenants see it as quite likely that they could face another retail shutdown or office closure ordered by the government and they do not want to bear that entire risk themselves. To entice these tenants to rent new space or retain their existing space, some landlords are now offering various rent discount mechanismsin the event of an ongoing or subsequent pandemic.
One example of such a clause negotiated by a retail property developer in Washington DC provided that 50% of minimum base rent would be postponed if the city government prohibited tenants from operating their business due to coronavirus going foreward. However this discount would need to be repaid over six equal monthly installments beginning on the first day after reopening. Some consider this a win win deal: the landlord is able to receive at least some rent money to defray its fixed expenses and the tenant is able to conserve cash flow at a time when it is not earning as much.
Other creative landlords are structuring leases based on a percentage of the retailer’s sales, which effectively limit the expenses of tenants if their sales decline. Historically, shopping malls are the place where landlords have been most active at including a percentage of revenue as part of the rent calculations. An extreme version of this occurred in Detroit, where a wealthy land owner agreed to waive base rents for many businesses in exchange for 7% of their gross sales.
Savvier tenants also realize that a pandemic may impact the timing of when they can open subsequent locations because social distancing restricts employee training and may make building inspectors unavailable as they are working from home. To balance these risks, some tenants are negotiating delayed starting dates for leases that are dependent upon external factors and personnel that could be impacted by a pandemic.
It is important for landlords to know about these trends and contemplate what they might be able to do themselves with their tenants in the event that a bankruptcy of a tenant either arises or is threatened because during the bankruptcy proceeding, the tenant in its role as a debtor could essentially reject the existing lease, leaving the landlord with an unsecured claim against the tenant. Being able to renegotiate the lease using some of these new market mechanisms, may result in the tenant assuming the lease and moving forward with the same space and same landlord after the bankruptcy proceeding has completed.
Proxifile and Enumero Law, P.C. regularly help landlords in renegotiating deals with their tenants, both in and out of bankruptcy.