COVID-19 is a threat of unprecedented proportions, a global pandemic jeopardizing health and economic stability around the world. The real estate and hospitality industries are important sectors in America’s economy, employing millions of people. The livelihood of employees and the viability of many real estate companies and quick-service restaurants is now in jeopardy.
The severity of the economic aftershock may be much more severe than it needs to be. Without short-term rent relief, many otherwise viable quick-serves may be forced to permanently shutter.
Social distancing has been one of the primary tools used to slow the spread of the coronavirus and “flatten the curve.” In order to effectively implement social distancing many shopping malls and retailers have been closed, impacting restaurants particularly severely.
The spread of the coronavirus continues to escalate as the due date for April 1 rent approaches. Quick-service operators find themselves in a difficult predicament, often obligated to pay rent on premises they are unable to use as contemplated. Moreover, in many instances failure remit the lease-rent places their businesses, and in some instances their personal finances (e.g., personal guarantees) in jeopardy.
In some instances retail real estate owners have volunteered to forego rent for a limited period of time. This includes grocery giant Publix, which also owns various retail properties. This also includes landlords such as Bedrock which waived rent, CAM and parking fees for three months. Taking a different tact, other landlords have stated that the April 1 rent is due and payable.
Some tenants have reached out to landlords indicating that they should not be responsible for rent on premises they cannot use as contemplated. Others have indicated they will not be paying the April 1 rent.
Can these diametrically opposed views be reconciled? Can restaurants prevent the short-term economic aftershock of the pandemic from permanently harming their businesses?
Landlords, Tenants, Lenders are Part of a Highly Interdependent Ecosystem
Landlords, tenants, and lenders a part of a highly interdependent ecosystem, retail real estate.
Landlords need tenants in order to pay their bills, which bills include mortgage payments, Common Area Maintenance (CAM) and Real Estate Taxes (RET). In turn, landlords are also dependent upon lenders, in many instances leveraging the purchase of retail properties with borrowed funds. Lenders are dependent on landlords to repay borrowed funds.
Collaboration Can be Used to Solve a Short-Term Impasse
The importance of collaboration is tried and true; moreover, collaboration is ingrained in the birth of the country, and succinctly captured by one of our Founding Fathers, Benjamin Franklin.
“We must, indeed, all hang together or, most assuredly, we shall all hang separately.”
Franklin uttered this warning after signing the Declaration of Independence in 1776. Franklin sought to convey how essential unity was to achieving victory in the Revolutionary War.
Right now many of us are hanging separately. Many tenants are reviewing their leases, seeking to determine whether provisions such as Force Majeure relieves tenants of their monetary obligations, namely the obligation to pay Rent. On the other hand, landlords are reviewing these very same provisions, noting that Force Majeure clauses are often narrowly drafted, frequently expressly exempting monetary obligations. Landlords are noting other provisions, such as the ones which provide that the obligation to pay Rent is an independent covenant, leaving the tenant responsible for monetary obligations regardless of circumstances. Some tenants are planning to counter with co-tenancy provisions allowing them to pay alternative rent if an anchor (or a specified percentage of the mall’s GLA or Gross Leasable Area) is not occupied and open for business with the public—with early termination rights often accruing to the tenant subsequently.
Retail leases are long and relatively complex documents. Depending on how heavily the lease was negotiated, there are often valid arguments to be made on both sides.
Pursue Concessions While Valuing the Relationship
Your relationship with your landlord is important; continue to treat it as such. Your landlord isn’t the problem. In fact, your landlord may be experiencing many of the same challenges you are. You have a rent obligation. Landlords often have mortgage obligations, along with CAM, insurance premiums and Real Estate Taxes.
Identify Objective Criteria that Support Your Requests
It is critical for quick-serves to thoroughly understand their rights and responsibilities before approaching their landlords to discuss restructuring. So, if you’ve made a determination to pursue a reduction in rent, the first step is to carefully review your lease, determining which provisions support such a reduction, and which are unfavorable.
Take the Landlord’s Interests into Account
Your landlord has needs. Take them into account during negotiations. For example, your lease may end in two years, and your landlord might be concerned about the expenses he will have to incur in order to lease the space to another tenant. These expenses include brokerage fees, legal fees, having to pay CAM and Real Estate Taxes while the space is vacant, landlord work, free months and tenant improvement allowance. In all likelihood, these expenses are substantially greater than abating the rent for the duration of the pandemic. Your agreement to extend the lease imposes no additional financial burden; e.g., you intended to enter into an extension and sell the business during such extension. However, the extension/concession may have a disproportionately high value to your landlord.
Trading Items of Unequal Value
Collaborate with your landlord. Get to know your landlord’s needs. Tenants that know their landlord’s needs are in a better position to satisfy such needs. When you satisfy your landlord’s needs, you make it much easier for your landlord to restructure the lease, granting the relatively short term reprieve many restaurants need in order to retain their long-term viability.
Generate Options for Mutual Gain While Avoiding Positional Bargaining
Landlords and tenants often engage in positional bargaining. A landlord may state that there will be no abatement during the pandemic, while his tenant insists that due to Force Majeure an abatement is merited.
Instead of engaging in this type of positional back and forth, work with your landlord to generate mutually beneficial options. Such options might include your referring another operator to the landlord, leasing another space in the portfolio or forgoing this year’s audit of the CAM Reconciliation.
Work with the landlord to generate options before judging them. Prioritize the most attractive options, particularly the options that further your interests as well as the landlord’s.
When Confronted With an Impasse, Resort to Objective Criteria
There must be some means of resolving the inevitable differences of opinion; these should be objective criteria. One key to effective negotiations is to identify a broad range of objective criteria that could apply. One set of objective criteria are provisions contained in the lease. Another objective criteria is the tenant’s inability to operate as contemplated. A third potential objective criteria may be the landlord being better off by providing some leeway, rather than insisting on strict adherence to the monetary terms of the lease, which may or may not be applicable under the circumstances. Concessions granted by other landlords are just another example of the broad range of objective criteria that can be brought to bear during negotiations.
Do Not Yield to Threats or Pressure
Focus on which objective criteria are the most appropriate and how they should be applied. Do not make negotiations personal. Attack the problem, not the people.
Many Shrewd Landlord’s Have Benefitted by Restructuring Retail Leases
Even before COVID-19 shrewd landlords routinely acted in their own best interests by granting concessions to tenants. For example, publicly traded Vornado reduced the rent for Forever 21 at 1540 Broadway, Times Square to less than half of that called for in the lease. Both parties’ interests were served, as Vornado negotiated for the right to terminate the lease early.
We’re living in precarious times, where our physical and economic health are threatened. For restaurant operators, rent constitutes one of your largest recurring expenses. Moreover, the terms of your lease are integral to your viability and success. There is nothing wrong with seeking to restructure an agreement whose terms have been overtaken by unforeseen events. Be sure to do your homework, investing the time needed to thoroughly understand the terms of your lease, the strengths and weaknesses of your position and the consequences of your actions.
A successful restructuring can prevent a short-term economic aftershock from imparting long-term damage to your brand.
Be well and best wishes.
Randall Airst is CEO of Exceedant, a platform for real estate owners, occupiers, lenders and investors seeking to optimize their investment in commercial real estate.
This article does not constitute either legal or financial advice. Every situation is different and solutions must be tailored to fit individual circumstances.