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COVID and the CRE Tenant Response

This article is from the SIOR Thought Leadership Series and has been republished with permission from SIOR.

As COVID-19 Forces Business Closures, SIOR Tenant Advisory Steps Up

 

As the coronavirus continues to wreak havoc on the world’s population and the global economy, the commercial real estate industry faces its most daunting challenges since the Great Recession. One of the most pressing issues for CRE professionals is the ripple effect occurring as companies leasing commercial space can no longer pay their rent. Not only will landlords be unable to meet mortgage obligations, but repercussions will be felt throughout the entire real estate financial structure.

With the announcement by the Trump administration that the voluntary national shutdown would be extended until April 30 to slow the spread of the virus, restaurants, non-essential retail, and many other industries already crippled by the pandemic are unable to generate income to pay employees or rent. Although the need for rent relief solutions vary by tenant, the prevailing wisdom from the SIOR brokerage community is to encourage tenants to seek rent abatements for 90 days, with payback distributed throughout the length of the lease.

“At our firm we are actively negotiating resolutions to lease and purchase issues as a result of the coronavirus, as well as preparing for loan modifications or workouts, which will be the next phase for our clients,” says Louis Archambault, SIOR, partner and commercial real estate attorney for the Miami office of Saul Ewing Arnstein & Lehr, LLP. “These are on a case-by-case basis, but the easiest negotiation is to abate rent for 2-3 months and add it on to the end of the term for a lease, or to extend a closing date 60-90 days for a purchase.”

Saul Ewing is adhering to the guidance provided by David Zimmer, SIOR, and his partners, who are extending the same to their tenants. Zimmer is principal of Newmark Grubb Zimmer in Kansas City, Mo., a brokerage firm that operates ten million square feet of industrial and office buildings as well as a retail center. Qualified tenants—not in default or with past due accounts—will be offered abatement on base rent for the months of April, May and June, and beginning July 1 can repay the rent—interest free—over the remaining term of their lease. Tenants also have the option to extend their lease for 12 months, with the abatement spread out over the amended lease. For Zimmer, it’s not only the right thing to do, it also makes good business sense.

“Whether the tenant repays [the abatement] over the remaining term of the lease or takes advantage of extending the term, it provides us with a benefit, because it affords us longer occupancy in our buildings without having to go to the market, renegotiate a lease, or face a vacancy,” says Zimmer. “I’m all about cash flow, about keeping my buildings occupied—not facing a vacancy, and having to retrofit a building and spend money on tenant improvements. As long as your building stays occupied, you avoid those expenditures.”

Because he carries little debt on his properties, Zimmer acknowledges that he is in a “fortunate” position with regards to his ability to offer rent abatements, unlike many of his counterparts that are more heavily leveraged. However, there are still lender obligations, taxes, insurance premiums, common area maintenance (CAM) charges, utilities, and vendors that still need to be paid. “So even if I abate rent for tenants, I still have financial obligations that I need to meet.”

“We also understand that this is a short-term crisis,” Duclos continues. “It seems long-term now, but we’re hoping that by say, late summer, this all clears out. And how do you want that to look? It’s either going to be carnage or we’re all going to work together and handle it with a united sense of purpose.

– Mark Duclos, SIOR

As a result, he is evaluating some lease modification requests with a degree of skepticism. While his local retail and small business tenants are struggling to remain afloat, there are some more resilient professional services businesses he feels are seeking to “game the system,” given the extraordinary circumstances. “I try very hard not to judge. I want to be a straight shooter and I would hope that the majority—if not all—of the tenants are straight shooters with me, but there are some that have left a sour taste in my mouth [with demands]” says Zimmer.

His skepticism is well-founded, as some tenants—particularly national chains—have launched preemptive strikes against property owners by withholding or reducing rent payments. Last week, the national restaurant chain Cheesecake Factory announced they would not pay April rent for their 300 locations due to the business shutdown. Sandwich chain Subway and retailer Mattress Firm also announced that they would suspend or reduce payments to property owners. Mattress Firm is citing the coronavirus as a force majeure (unforeseeable event) that “will prevent or prohibit us” from paying rent, and Subway issued a letter to landlords stating that the company reserves its right to “abatement or postponement of rental payments.”

In Europe, the prospects for landlords collecting rent are even dimmer, according to Charles Tatham, SIOR, of Tatham Property Solutions in Paris. The coronavirus has hit Western Europe especially hard, with a mortality rate three and a half to six times higher in Italy, Spain, France, and the U.K. than the U.S. is currently experiencing, necessitating varying degrees of lockdown in each of those countries. He says major landlord groups in France have preemptively suspended rents, or are billing on a monthly—as opposed to a quarterly—basis, and not pursuing non-payers. “The usual fabric of commercial life has effectively broken down,” says Tatham.

The French government has taken extraordinary measures to see that businesses do not fail, guaranteeing hundreds of billions worth of loans, delaying tax payments and suspending rent and utility bills for smaller firms. “And the private sector is trying to find appropriate measures to help out, so the more people talk, the better,” says Tatham. “But the savvy tenant is going to say, ‘If the government is letting me off of [my obligations], why would I cut a check to my landlord? Because there are no bailiffs to serve and no courts to judge.”

Back in the U.S., tenants may have a more difficult time getting out from under their obligations, according to Archambault, particularly those seeking to curtail paying rent through force majeure. “The force majeure provisions, for the most part, are more about landlord protection than the tenant’s ability to pay rent,” he opines. And he is not optimistic the concept of Force Majeure will be broadened in the future by the courts, as judicial appointments have recently trended toward strict constructionist judges, which typically stick to the plain language of a contract or statute.

“When the issues related to the pandemic inevitably hit the courts, our current expectation is the courts will hold that if a contract or statute does not specifically provide an issue is covered by the language of the respective contract or statute, the court will not broaden the language provided,” says Archambault. “However, this may change due to the magnitude of the pandemic.”

On a more optimistic note, Archambault says that most landlords are willing to work with tenants on modifications, simply because, “if before the pandemic you had a performing tenant, why would you want to go replace them?” Tenants should be prepared to produce supporting financial documentation, however, as landlords want to be sure that tenants are being truthful regarding their ability to pay. Landlords will also need that documentation to show lenders and/or investors, so “that they will understand that while [the landlords] were being proactive, they were also being diligent, and I think that’s a reasonable request,” says Archambault. He also reminds his clients that the CRE business is still about people, and business associates will long remember how individuals and firms conducted themselves during the crisis.

That sentiment is echoed by SIOR president Mark Duclos, SIOR, co-founder and president of Sentry Commercial in Hartford, Conn., who says that his clients—tenants, landlords, buyers, sellers, lenders—all understand that they’re part of the same food chain, and if one link is broken, it’s going to affect the entirety of the chain. “So landlords understand that if they absolutely crush the tenant, then you lose the tenant and the ability to pay your mortgage,” says Duclos.

“We also understand that this is a short-term crisis,” Duclos continues. “It seems long-term now, but we’re hoping that by say, late summer, this all clears out. And how do you want that to look? It’s either going to be carnage or we’re all going to work together and handle it with a united sense of purpose. The response of the landlords and lenders can greatly reduce the effects of the pandemic while maximizing and accelerating the recovery.”

About the Author: Michael Hoban is a Boston-based commercial real estate and construction writer and founder of Hoban Communications, which provides media advisory services to CRE and AEC firms. Contact him at michaelhoban@comcast.net

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