COMMERCIAL TENANTS: SHOULD YOU PAY RENT DURING THIS CRISIS?

In my opinion, the answer is generally no; don’t pay your rent for now.

Why?  Because it’s probably the only leverage you have over your landlord right now, and it is good leverage which most tenants don’t typically have with a landlord. A relevant Costar News Article discusses how The Cheesecake Factory is one of many examples of a business that has found it impossible to pay rent.  If you pay your rent as usual, why would a landlord offer you any kind of help?

I have been receiving many calls from business owners from existing clients and those that are becoming new clients related to what they should do regarding their commercial real estate leases.  Negotiate to terminate the lease early, sublease or assign the leased space, apply for governmental aid, make an insurance claim, etc. are some of the potential options. There are pros and cons to each option but one of the best options for a tenant right now is to simply not pay your rent.

Not paying your rent might not be a good idea if your landlord has offered you a reasonable alternative such as not paying rent now and adding on the deferred rent to your lease. This could be done either at the end of your term, via a term extension for three months, or whatever length of the deferred rent amounts to in months, or in some other fashion like raising your rent in the future to recoup the abated rent.  However, if this doesn’t work for you for some reason, then you have to find a different solution like one of the ones mentioned in the paragraph above. Here is a link to another article on this subject that you might find of interest.

But what if you ask the landlord for some kind of help and he isn’t responding to you?  Then in my opinion, not paying your rent could be your best option. Landlords and lenders both don’t want empty buildings as landlords might give a building back to a lender if too many tenants aren’t paying rent or vacating.  My experience is that by not paying rent you will get your landlord’s attention and get a response with what the landlord is willing to do for you quickly.

Some of my clients I have spoken with are worried about litigation if they don’t pay their rent.  “Won’t the landlord evict me?” or “Won’t this hurt my credit?” The answer to these questions is that the courts aren’t open now and might not be for some time. And if the landlord has to spend a lot of money on legal fees chasing a lot of tenants and creating a lot of vacant space at their property that traditionally has not gone well for a landlord or a lender.  Also, you can always change your mind and pay the rent once you get a notice of default as long as you pay within the allotted time but even then most times I would probably recommend that you still don’t pay.

Doug Schneider of Alabama-based Bayer Properties knows what store and shop owners are struggling with amid this COVID-19 crisis. In a recent Costar News article, Tony Wilbert states: 

“To help, Schneider, the executive vice president of operations at Birmingham, Alabama-based Bayer Properties, is starting a program to help tenants access some of the money available to them as part of several federal programs, including the Coronavirus Aid, Relief, and Economic Security (CARES) Act and Small Business Administration Economic Injury Disaster Loans (EIDL). Tax credits are available under expanded provisions of the Family and Medical Leave Act as well, he said.”

Here is another great article from Bisnow: The Coronavirus Tenant-Landlord Playbook Revealed.

Each situation is unique and needs to be figured out carefully, so run it by your attorney, CPA or other counsel if you want help making the right decision on how to handle what you should do regarding your commercial lease.   I have settled these types of matters both as a landlord and tenant hundreds of times so I can assist you if you need help. Reach out at david@djmcre.com or 805-217-0791.

Here is a resourceful list of additional relevant articles:

 

Tenant Rent Abatement During This Crisis

Many businesses are experiencing the same income drop that you and I are.

In a relevant Costar article, Brad Tisdahl states:

 “The people I’ve been in contact with are asking, how long and how serious is this going to get,” said Tishahl, adding he’s recently received a steady stream of inquiries from current and prospective clients. “Landlords want to get a sense of what they should be doing if they’re getting a lot of rent-relief requests.”

While it is true that many businesses are experiencing income drops, the landlords probably won’t give a rent reduction of any kind because they are going to have losses also as many businesses, especially in retail centers, will go out of business.

It doesn’t hurt to ask your landlord for a rent reduction, but you are going to have to prove your income drop, which is not normally something you do in advance, but rather in arrears after many months of the loss.  You also have to prove that you don’t have enough other financial resources to cover your debts without this income and that you are probably going to terminate the lease early if they don’t help you in some way.

However, no landlord I am aware of will even consider a rent reduction without a tenant sending them proof of their losses and showing they don’t have sufficient assets to cover these losses on their own.

The First thing I would recommend is checking with your insurance carrier to see if you have business interruption insurance (you probably do) and to see if it covers mandatory required government closings and loss of business income otherwise for any other applicable events.  There is usually a 90 day waiting period before a claim can be made on such policies. Click here for a promising link about this type of coverage. The main point here is to make the insurance claim so if your insurance company either decides to cover it or is required to cover it by the government you are in the queue before the other thousands of claims that will come in. This is to ensure, if there is coverage, you will get your money earlier than those who waited.

Landlord’s also have loss of rent insurance so you can check with your landlord to see if their coverage is in effect; if it is they will allow you not to pay rent. Because landlords will have to make a claim, I am recommending they do it sooner rather than later, even if they think there probably won’t be coverage. This is for the same reasons mentioned above regarding your business interruption insurance.

Many tenants are going to be in the same situation as you, so something will have to be done, or the landlords will have a lot of empty space.

In my opinion, your options regarding your current lease are the following: 1) Give back part of your space to the landlord. I don’t think this will appeal to your landlord much because currently the demand for space is very low and it will not be easy to lease it; 2) Sublease part of your space to others, especially those that might be potential referral sources for your business; you might actually end up receiving more rent than you are paying this way, but you also might want to make a better deal for someone who is a potential referral source for you. However, it might not be easy to sublease quickly because of demand for office space right now; 3) Terminate your lease early and relocate to another space in the building or to another property. Again, I don’t think this will appeal to your landlord but they may accept this option, or option #1 because it’s better than losing a tenant entirely. Moving to another property would be a more aggressive approach, but in my experience and opinion, you can usually get out of any lease for 6-12 months of your current rent. California usually requires landlords to mitigate a tenant’s lease damages, and the courts time and time again have stated this is the amount of time it should have taken the landlord to release your current location. I rarely see any award over 12 months of rent, but in most cases, the courts have awarded between 6-9 months of rent, as it really depends on your current market and how fast space is leasing for your particular type of space. 

In a recent Bisnow article, Michael Huddleston states:

” Waiting for the government to force closure is a dangerous game of damned if you do, damned if you don’t, Huddleston said. “The problem is if you voluntarily shut the business down, and you have one of these policies that provide the coverage for when the civil authority shuts you down, you are going to potentially lose the coverage or at least limit the coverage if you shut down before the civil authority acts,” Huddleston said.  “[But] if you wait for the civil authority to act, then you are potentially incurring liability to patrons coming in because you know there is a danger … that’s a liability exposure.” 

I can help you with all of the matters mentioned above, but if you reach out to your landlord to see what options they offer, it won’t hurt.

I hope the above helps, and let me know if you want to discuss any of the above further, as each option has many more details that need to be considered.

Here are two additional resourceful articles on the topic:

Before You Break That Lease Over COVID-19, Negotiate First, Brokers Say

Force Majeure And Business Interruption Insurance May Not Be The Solution CRE Hopes 

If you have questions about selling, buying, or leasing CRE or have any other CRE needs, please contact David Massie at david@djmcre.com or 805-217-0791.

DANGER: USE AND EXCLUSIVE USE CLAUSES IN COMMERCIAL REAL ESTATE LEASES

Pay attention to how your use clause is written in your lease.  If you don’t, it could come back to haunt you and cost you in many ways. 

Although all tenants need to pay attention to this and make sure the use clause is written correctly, retail tenants need to do this the most.  Imagine you are a retail tenant and you sell a food item, for instance, coffee, as part of your menu.  How do you make sure you always have the right to sell coffee under the terms of your lease?  It’s not as simple as it sounds.  And what if you don’t want other tenants to have the right to sell coffee?  This is where the exclusive use clause comes in.

It is my opinion that a tenant should have a broad use clause.  Example:  “Tenant shall have the right to sell food products”.  That way, the tenant has the right to pretty much sell any type of food product.  But for a landlord, it would be better to limit the use clause to something like “ Tenant shall only have the right to sell coffee and coffee-related drinks”.   In practice, savvy landlords and tenants end up writing the use clause somewhere in between the aforementioned two options.

The exclusive use clause is different than the usual use clause and adds to it in that it should prohibit or severely limit another tenant from selling your main product.  But again, how the exclusive clause is written is of paramount importance.  Example:  “Tenant shall have the exclusive right to sell coffee at the Project” and it might add “except for up to 10% of another’s tenant’s gross income” or something like that with more details for clarification.

The above examples are for retail tenants but the same principle holds true for office, industrial or other types of leases also.  If these clauses aren’t written just right you can have a legal battle on your hands and if the clauses weren’t crafted correctly you probably won’t win the battle so I urge great caution.

I have written and studied thousands of use clauses and make it a priority for my clients to do it right.

If you have questions about any of the above topics or have any CRE needs, please contact David Massie at david@djmcre.com or 805-217-0791

How to Terminate a Commercial Lease Early

Many of my clients have stated, “I don’t want to sign a long term lease like 5 years or more because I’m not sure I will be in business that long or might need more or less space.”   My answer to them?  It’s usually in their best interest to sign a long term lease and there are ways to terminate a lease early.

Signing a longer term lease between 5-10 years makes good sense for many reasons.  You normally get the best economic deal that way with lower rent, more free rent and more tenant improvements paid by the landlord.  You normally get more options like renewal options with more time.   You don’t have to worry about moving sooner either or having to pay a much higher rent in 1-3 years if the market rates increase.  Keep in mind that many landlords won’t agree to less than a 5 year term, especially for space in demand where another party will lease it for 5-10 years, so it will really limit your options for properties if you want to do less than a 5 year term.

If you need to terminate a lease early, you have many options available to you.  You can request an early termination option of the landlord in your lease, but most landlords don’t like to grant them.   If they do, they want enough time to release your space so a 6-12 month notice from you might be required.  You might then have to pay back unamortized tenant concessions like free rent and tenant improvements.  But this is still a good option to have if you can get it.

What if you can’t get the landlord to agree to an early termination option?  There are still other good options like having the right to relocate in the project to a larger or smaller location.  You also generally have rights to sublease or assign your lease to another qualified tenant.

If none of the above options work out, then you can still legally terminate a lease in most states like California.  Courts usually require a landlord to mitigate a tenant’s damages.  This usually means the landlord has to take reasonable steps to re-lease the space, but this mitigation usually only starts after you vacate the space –not while you are in it.  However, I have seen most legal awards and arbitrations settle between 6-12 months of rent.  This is generally the most a landlord can squeeze out of a tenant in Southern California.  This can be a tricky matter, so you have to make sure you do it right and use someone familiar with the process like me or a good real estate attorney. You might need both.  But I have been very successful negotiating an early lease termination for my clients.

Contact David Massie for more help:   805-217-0791 or david@djmcre.com

Round 3: What Tenants & Landlords Should Know About Operating Expense/NNN

In my last article on operating expense and NNN pass throughs in a lease, we looked at how expensive it can be for a tenant to pay their share of unreasonable property management fees.

This month, we look at another expense passed through to tenants where landlords commonly pad the number in their favor: Salaries.

You are probably already paying your share of property management fees.  Now, in addition, you have to pay for salaries for everyone that works at the property from janitorial to maintenance to property managers and maybe even more.

I am currently involved in an operating expense audit where the landlord has decided that from one year to the next it is reasonable to increase these salaries by more than 50%.  In addition, the actual hours worked at the property didn’t substantially increase.  How is this possible?  Because the landlord sold off some his properties and he allocated his employees’ salaries over the properties he owns.  So, the less property the landlord owns the more you as a tenant pay for your share of this category.  Needless to say, I think my client is going to prevail in the matter –especially since I negotiated the lease before it was signed so that this kind of thing won’t happen.

What is a tenant to do?  How can a tenant get the landlord to be reasonable here?  That’s where I come in.  Having directed some very large landlord companies for over 25 years has given me great insight into how to help a tenant in this area.  But you have to have a broker and/or real estate attorney savvy in this area who can set the lease up correctly or you might be stuck paying these kinds of unreasonable expenses.

This is just one of many examples of operating expenses/NNN a tenant is exposed to in most leases.  Most tenants and even landlords don’t really understand this particular issue until it happens and it’s too late.  Stay tuned for my next blog with more examples and even some savvy advice for landlords on my recommendation for how to negotiate the lease in this area and calculate these expenses correctly so you don’t end up losing the tenant at renewal time and/or get into expensive litigation over this matter.

If you are a tenant or landlord and want to find out how to avoid pitfalls related to leasing, buying, or selling, please contact me as I have in depth experience and knowledge in these areas including operating expense/NNN audits related to commercial properties.

Every tenant and landlord should have their operating expenses audited by someone that understands them fully to make sure they are correct.  If you don’t, it will cost you.

Best Way To Sell Commercial Properties

Right now is a great time to sell commercial real estate in general, but especially in Southern California where my primary market is.  Why?  Sale prices are at all-time highs, there is very limited supply inventory (so not much on the market for sale), and all kinds of buyers are looking to buy what little amount there is available for sale –driving up prices with multiple bids usually.

So, why should a seller hire a broker and pay him a commission when a seller can do it on their own?

  • Simply put, the seller will not be able to get the maximum price that a good broker can.   Many brokers have clients waiting in the wings to buy a property and these clients will pay top dollar if they are allowed to make the offer first.  Also, the price a broker is able to sell a property for more than pays for their commission.
  • Sellers don’t have the same marketing ability as a broker.  The world has become international and your reach has to be international.  The dollars are flowing into the US from other countries right now and international buyers are willing to pay more many times.  Brokers also know what is needed in terms of a marketing package to interest buyers. It’s complicated, expensive, and time consuming to put this package together properly.
  • The timing of when to put the property up for sale is critical.  When is the market peaking?  Is there a lot of competition on the market for sale now?  Good brokers will usually know what is for sale on the market as well as off market, but sellers won’t.
  • The repairs that you need to make to the property before you put it on the market are also important.  Some are worth making and some aren’t.  A good broker usually knows what to recommend.
  • What should the asking price of the property for sale be?  What if there are no comparable prices for the sales price because the sales price is higher and the property won’t appraise for the sales price?

There are many other factors in selling a commercial real estate property; but, in my opinion, it starts first and foremost with the right broker.  Doing it on your own is always a mistake.  If you don’t hire the right broker or if you do it yourself, it will cost you.  I have seen it many times.