The COVID-19 pandemic has disrupted our health care system, our economy, and our way of life. Leaders across the country are adapting to the new normal and are working diligently to mitigate many of the emerging problems disrupting their business and organizational models. One of these problems, and likely one of the largest, is cash flow. Real estate occupancy costs are typically a significant expenditure for any business and organization. Ideally, deferring or abating rent in the short term would be a solution. The following provides some general guidance on rent relief options to help mitigate cash flow expenditures during this time of uncertainty.
There is no “one-size-fits-all” approach to negotiating rent relief. By nature, real estate is unique, and each tenant’s situation will have its own set of driving factors and issues that need to be considered. Landlords are also unique, and will differ widely in their financial capability, risk tolerance, and sophistication. These variables will impact results.
In most situations, when rent relief is needed, it is needed quickly. To help expedite conversations and drive toward results, tenants entering or requesting negotiations with landlords should be prepared with the following items:
- A narrative outlining how the stay-at-home or shelter-in-place order has impacted business
- Copies of recent financial statements and projections
- Descriptions of other actions the tenant is pursuing to alleviate financial issues
- A definitive and clear “ask” for specific rent relief needed by the tenant
- A proposed lease amendment in executable form
These items will help asset managers, investment committees, and lenders understand the situation the tenant is facing and make educated decisions. The items proposed above are all straightforward; however, the form of rent relief a tenant should ask for is not. What should tenants ask for? What can they ask for? What proposed terms and conditions are landlords accepting? These answers vary across asset class and market.
Tenants may request straight rent forgiveness from their landlord. As the name implies, this form of rent relief involves the landlord temporarily forgiving rent payments for a specified period. Tenants may also request partial forgiveness, which provides a temporary discount on rent for a specified period. The tenant is not required to pay back the forgiven amount in this scenario; therefore, this form of relief results in the largest benefit for the tenant and the largest detriment for the landlord. This structure is rare, but can be successfully negotiated in situations where one or more of the following factors are present: i) a long lease term; ii) a friendly/positive relationship between the landlord and tenant; iii) a synergy with other tenants; and/or iv) a stable financial position of the building.
Rent Forgiveness in Exchange for a Lease Extension
Tenants may ask landlords for temporary rent relief in exchange for an extended term. This form of rent relief involves a temporary pause in rent payments for a specified number of months, along with a lease amendment extending the termination date by a corresponding amount of time. The rent payments due during the extension may reflect the amounts in the original agreement or may be increased based on negotiations. This structure is more common than straight rent forgiveness. Tenants experiencing short-term cash flow liquidity challenges may request this form of relief, particularly if they believe business operations will resume to pre-COVID-19 levels following the stay-at-home order. Landlords may elect this form of rent relief as it maintains building occupancy, protects and lengthens future cash flows, and avoids the hassle (and costs) associated with default and eviction proceedings. Ideally, tenants may trade one month of free rent for a one-month extension, though more often than not, the ratio is higher than 1:1, and may be as high as 1:12. Landlords will surely attempt to use this request as leverage to obtain a disproportionate lease extension. The longer the lease extension commitment, the more critical it is for the tenant to understand future space needs.
Rent Forgiveness in Exchange for Additional Amortized Rent
Tenants may also ask their landlords to provide temporary rent relief and amortize the rent relief over a specific time frame during or through the existing lease term. The amortization period is generally the remaining term of the lease, but some landlords may require a shorter period in order to recover the lost income sooner. This structure is more frequently seen with sophisticated landlords, the majority of which, will amortize the rent at their respective costs of capital ranging from 8% to 10%. For tenants, this structure may provide an option for rent relief if the other structures are unavailable as it allows landlords to maintain the current lease timeline and results in the rent relief being paid back the soonest of all the options. From a tenant’s perspective, while not as favorable as these other structures, this option is better than no rent relief at all, assuming there are no other less expensive costs of capital options.
Rent Forgiveness in Exchange for the Surrender of Tenant-Friendly Lease Provisions Tenants
In certain situations, tenants may have lease provisions in their current lease, that if relinquished, could be used as valuable concessions benefiting the landlord in exchange for rent relief. These provisions could include operating expense caps, termination rights, expansion rights, renewal options, and rights of first refusal. The ability to monetize these lease provisions could be another cost-effective solution for tenants to leverage into rent relief while also benefiting the landlord by using a non-traditional approach.
It Depends on the Situation
The above list of rent relief options is not exhaustive. There are a number of creative or hybrid approaches which can be crafted to meet the needs of all parties. However, it should be noted not all landlords will entertain these overtures. It does take a willing partner to work through these types of issues. Keep in mind that many landlords are also suffering financial distress during the COVID-19 pandemic. In the case of a landlord that is not willing to entertain the conversation, tenants have few options other than default. This action may create the leverage to get the landlord to the negotiating table, but it is also a highly risky maneuver with unpredictable outcomes.
Tenants who are curious about what options are available should reach out to an expert real estate professional to review their leases, assess existing market conditions, and develop a go-forward strategy that will yield the best outcome given the current situation. Allegro is staying up to date on the rapidly developing hurdles for tenants during the pandemic. If your real estate is disrupted by this economic shutdown, and you would like to know how our professionals can help you with your real estate, please contact Damon Taseff at [email protected].