How Your Landlord Will Approach a Rent Relief Negotiation During the COVID-19 Crisis
The COVID-19 pandemic is causing businesses to scramble and find ways to stay afloat until things return to “normal.” With limited ability to control their revenues, companies are turning their attention to the expense side of their ledger. Because real estate represents one of the largest line item expenses for many businesses, and these businesses are not being allowed to occupy their space, many tenants are looking to reduce or even stop their rental obligations. The problem is, landlords have businesses too and cannot afford to offer relief to
every tenant seeking help.
In order to maximize the possibility for a successful rent negotiation with one’s landlord, the tenant needs to understand the landlord’s legal position, constraints and frame of mind. Only then will the tenant be able to anticipate issues and develop a solution that works for everyone. Here are the key factors to keep in mind:
- Your Landlord is Probably Legally Entitled to Your Rent. In order to protect the interests of lenders, the laws in most states provide that the tenant’s obligation to pay rent is an independent covenant and applies irrespective of alleged breaches of the lease by the landlord. While there are some exceptions to this at common law (constructive eviction) or in the lease document (casualty, major service interruption etc.), unless the landlord has done something wrong or there is physical damage to the property which, in either event, prevents the tenant from occupying the space, tenants will normally have to continue to pay rent. As COVID-19 did not cause physical damage to buildings (some are attempting to argue that the germs present in the space are in fact damage), and it wasn’t caused by landlords, most experts believe that tenants are going to have to pay rent during the COVID-19 crisis. Landlords will begin any rent relief negotiation by stating this position.
- Your Landlord Probably Has a Lender. Even if a landlord is inclined to help a struggling tenant and agree to some sort of rent deferral or abatement, he may not be able to do so unless the lender consents to it. Most mortgage documents prevent a landlord from modifying any lease or agreeing to any rent concession without the lender’s consent. These provisions ensure the borrower cannot unilaterally impair the lender’s collateral for the loan. While your landlord may value your long-term tenancy and the friendship you have developed over the years, the lender is more removed from these dynamics and emotions and is primarily focused on getting his loan paid. You’ll need to convince the lender that your plan makes sense.
- Your Landlord Also Has Bills to Pay. A good portion of the rent you pay goes to cover the operating expenses of the property, real estate taxes and, in most cases, debt service on the underlying mortgage. If you stop paying your rent, it’s possible that the landlord will not be able to pay her bills and could lose her property unless she can gain concessions from her creditors. If your landlord cannot secure relief from her obligations, your proposal will need to cover the landlord’s costs.
- Your Landlord May Have Other Tenants Asking for Relief. In normal times, a landlord often has flexibility to deal with a one-off tenant who is facing financial difficulties. Today, however, almost every business is being adversely impacted by the COVID-19 crisis and, as a result, landlords are getting inundated with calls from tenants asking for rent relief. If landlords granted concessions to every tenant who said they were adversely impacted by the COVID crisis, they’d be out of business very quickly. As a result, absent legislative action or moratoriums on debt service payments granted by lenders, landlords are going to have to pick and choose which tenants they will help. To the extent a landlord can grant concessions, he will most likely choose the most critical tenants and the ones who are most likely to survive this crisis long-term. Likewise, the landlord will focus today on the tenants who are in most imminent danger of defaulting. If one tenant will run out of money in 30 days and another in 120 days, all else being equal, the landlord will probably focus on the more immediate problem. In these unique times, rent relief is a bet on the future, and landlords will make the bets that are likely to yield the highest returns. You’ll need to make your case.
- Your Landlord Will Assess Her Leverage Before Making any Decision. Just as you as the tenant will assess your relative strengths and weaknesses before sitting down at the negotiating table, the landlord will do the same. That means she will review your lease to see if it has any security deposit or guaranties that she can draw down if you fail to pay rent and will carefully review its remedies to see if any create significant pressure. If the owner of the tenant’s business has personally guaranteed all or a material portion of the lease obligations, or if the tenant has posted a material security deposit or letter of credit, the landlord will have significant leverage over the tenant and probably be less likely to grant immediate relief (at least until the security deposit is exhausted). Again, the landlord will most likely focus rent relief on the tenants for which she has less protection and more immediate payment risk as long as she believes this is a temporary condition and that the tenant has good long term prospects once the COVID-19 pandemic recedes. You’ll need to review your lease and be prepared for the levers the landlord will apply.
- Your Landlord is Probably Going to Play Poker. Ultimately, the question your landlord is going to have to answer is “Who is going to blink first if I do nothing?” In other words, if the tenant is running out of money and cannot afford to pay bills, her ownership group will have two choices: (1) get the landlord and other creditors to keep the tenant’s business afloat by granting necessary rent and other concessions, or (2) do what’s necessary to keep the business viable by infusing more equity into the business or taking on more debt. Before a landlord agrees to share the tenant’s financial burden (i.e., option 1), he is going to want to make sure that tenant’s ownership is not willing or able to come to the rescue (i.e., option 2). The more money the owners of tenant have invested in the business and the more profitable the business has been (and is projected to be after the crisis), the more likely it is that the ownership group will not risk losing its investment if it has the resources to save it. On the other hand, if the landlord has invested a lot of money in the build-out of the tenant’s space and there are no likely replacement tenants in the immediate future, he will be more likely to protect his investment and work to get the tenant through the difficult period. Both sides will likely test the other before agreeing to bear the total burden. It may come down to a game of poker and a split pot.
How Best to Approach Your Landlord
Given all of the foregoing realities, what’s the best way for a tenant to move forward in seeking rent relief? Although the law and most lease documents work against the tenant, the tenant has equity and fairness on her side. The fact is tenants today are paying rent for space they are not allowed to occupy. It’s no one’s fault, but why should the landlord get 100% of the benefit of the lease bargain (i.e., full rent) while the tenant gets none of what she bargained for (i.e., the ability to occupy the space)?
This doesn’t seem fair. We find ourselves in this situation because the law and lease documents have evolved over time ultimately to protect the interests of lenders. If tenants had the ability to stop paying rent every time there was a dispute with their landlords or they were having financial difficulty, nothing would be financeable, and the real estate industry and capital markets would shut down. That’s fine in normal times, but we’re not in normal times. Lenders will need to become a major part of the solution as we try to keep our economy alive.
The best approaches by tenants will be those that rely on fairness and equity, work within the realities of the landlord’s own financial obligations and perhaps offer upside potential to landlords who effectively agree to become their business partners during the pandemic. Both parties will need to think outside the box by
structuring deals that neither contemplated before.
Before approaching their landlords, it’s critical that tenants first understand the landlords’ legal positions, the constraints they face and their perceived leverage under the circumstances. By taking these into account and using the right approach, tenants will have the best chance for success.
Glenn Blumenfeld, as one of the principals of Tactix since 2003, has managed or co-managed many of the largest and most complex real estate transactions in the Delaware Valley, representing various law and professional service firms and institutions, as well as other corporations. Additionally, Glenn was the founding CEO of Exis, which currently has offices across 4 continents, including 21 in the US.