As businesses seek to navigate the coronavirus chaos, commercial tenants are finding safety in numbers. Word has gotten out that prominent tenants are seeking rent relief from their landlords, and other tenants are increasingly making similar requests. Indeed, a market that favored landlords less than a week ago has suddenly turned on its head.
With the number of rent modification requests rising, landlords are facing new dilemmas: Is it better to accommodate distressed tenants or keep cash flowing? Does one take a blanket approach to rent relief, or should each tenancy be evaluated separately? While a uniform strategy will not be appropriate for all landlords, many will find it prudent to prioritize intermediate and long-term goals by taking an active and flexible approach to short-term challenges.
Landlords can manage the attendant costs of high-volume rent relief requests by developing a pragmatic strategy that balances the needs of tenants and landlords alike. A successful strategy may include four steps:
- Communicate a Standard, Initial Position – As we have seen, the speed at which the coronavirus has spread has led to inconsistent and often conflicting messaging from tenants. Some have proposed reduced rent arrangements only to announce a complete inability to pay days later. To simplify coronavirus-related communications and minimize the “noise” of rapidly evolving positions, landlords may want to adopt a default, initial communication regarding tenant concerns. Such communication can be disseminated preemptively or as an initial response to tenant correspondence, but it should include the following elements:
- Sympathy – Convey appreciation of the difficulties presented by the coronavirus and express sympathy for the tenant’s position. Avoid florid language like “extraordinary”, “crisis” and “unprecedented”, as it may have unintended legal effects (e.g. strengthen arguments that a force majeure event has occurred).
- No Immediate Modification or Waiver – State clearly that, at present, the lease remains unmodified and in full force and effect and all payment obligations remain as scheduled.
- Commitment to Ongoing Monitoring – Communicate that you will continue to evaluate the tenant’s position as the situation evolves and that you remain available to address specific tenant questions and/or concerns as they arise.
Ultimately, the aim is to approach coronavirus-related tenant communications from a thoughtful and measured baseline.
- Understand Third-Party Consent Rights – Landlords should review their material contracts to understand consent rights that third parties may have over lease modifications. Credit agreements in particular may restrict a landlord’s ability to offer rent relief without prior, written approval from creditor(s). Since the approval process can take time (even in normal conditions), reviewing third-party agreements now and discussing consent rights with the appropriate counterparties can facilitate discussions with tenants and allow landlords to avoid unnecessary defaults.
- Actively Monitor and Assess Tenant Concerns – Landlords should regularly reevaluate tenant concerns in light of new information. Tenants with tight operating margins will generally require payment relief sooner than those with softer margins, and periodic reassessment of tenant positions will help landlords appropriately time the implementation of such relief, if appropriate. The goal is not to delay payment relief, but rather to manage it so as to avoid unnecessary cash flow volatility and going concern risk.
- Consider Appropriate Relief on a Tenant-by-Tenant Basis – Forcing a payment default in this climate is not productive. Cities and counties are adopting emergency measures that provide coronavirus-related rent relief and restrict landlords’ abilities to evict tenants for nonpayment of rent. Moreover, landlords that are perceived to have acted rashly or unsympathetically face reputational risk (e.g. among existing and prospective tenants), potential loss of brand equity, economic risk (e.g. tenant flight) and risk of litigation.
Landlords can avoid and/or mitigate these issues by approaching tenant relief methodically. A landlord’s immediate goal is likely to be stability – avoiding near-term tenant churn and preserving cash flow. Because each tenant’s needs will be different, a one-size-fits-all solution to rent payment relief can be inefficient. Landlords can, nevertheless, approach rent-relief discussions through a uniform framework. Consider the following points:
- Limited Focus – Coronavirus concerns are not a pretext to reopen a lease. Negotiations relating to coronavirus-related payment issues should be limited to these concerns. While some landlords may want tenants to provide additional credit support (e.g. personal guaranties and/or letters of credit) in exchange for rent payment accommodations, it generally is not advisable to extract concessions at this juncture.
- Pragmatism – The goal is to get tenants and landlords alike through this turbulence with as little damage as possible. Landlords should communicate that they too need to survive and endeavor to engender reciprocal understanding (if not sympathy) from tenants.
- Immediate Tenant Needs – Landlords should understand precisely what the tenant is requesting. What is the nominal value of the request? How long will expected cash flows be disrupted?
- Financial Tolerance – Ideally the landlord will have a well-developed financial model that will allow flexible analysis of cash flows and landlord liabilities. The landlord’s ability to withstand payment disruptions will be a function of duration, magnitude and available sources of cash and credit. Can the landlord withstand the accommodation sought? If so, for how long?
- Middle-Ground Relief – Can the tenant accept something short of what it is requesting? What if the landlord agrees to reassess the suitability of the accommodation in the near term? Landlords may want to adopt a cost-based-pricing approach to near-term financial accommodations (i.e. temporarily forgoing profit and basing the nominal value of relief solely on the landlord’s aggregate cost in allowing the tenant to operate in the leased space).
- Duration – Any accommodations granted should be of limited duration. Accommodations can be extended, but tenants should not take advantage of relief given. As things stabilize and tenants become surer of their economic footing, rent payments should resume (even if partial). Limited-duration relief ensures that the landlord can periodically assess improvements in tenants’ financial position and end or reduce accommodations to the extent no longer needed.
- Transparency – Unless already available under a tenant’s lease, a landlord may want to require periodic financial reporting in order to independently evaluate a tenant’s solvency.
- Documentation – Any accommodation should be carefully drafted to ensure that a landlord’s rights are reserved and that no modifications or waivers can be deemed to have been made. The documentation can be short, but careful wording is imperative.
It goes without saying that these are unique times. With thoughtful and pragmatic approaches to pressing tenant concerns, landlords will be in a stronger position to emerge from this crisis intact.
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Christopher R. Barry is an associate at Gibbs Giden. He focuses his practice on real estate transactions, including purchase, sale, financing and commercial lease transactions. Mr. Barry also has experience in a variety of corporate matters including mergers and acquisitions, corporate governance and entity formation. Before pursuing law, Mr. Barry worked in the financial services industry, most recently for a global investment bank.