By: Donna Faye Shetley, Partner at Johnson Smith Hibbard & Wildman Law Firm, LLP
COVID-19 measures by federal, state and local governments will likely have a profound impact on commercial real estate. Landlords will have to address the fact that tenants may be struggling to survive. While these tenants seek to reduce their costs, landlords must find ways to preserve their cash flow and maintain occupancy to ensure long-term financial stability. We believe based on the law firm’s past legal experiences during the financial crisis that occurred a decade ago that landlords and tenants can employ a variety of strategies to provide a balance for today’s COVID-19 environment. Below are some examples:
Rent Reduction. The landlord can reduce the tenant’s rent for a portion of the term left on the lease. The usual forms of rent reduction are to reduce the base rent, operating expenses, or both.
Rent Deferral. In this case, the landlord can defer a portion of the tenant’s rent but would require them to repay the rent deferred at a later time, either in a lump sum or by increasing subsequent payments. A variation of rent deferral could be to cap or set a base year on the operating expenses for a short or extended period of time.
Rent Abatement. If a tenant is significantly past due on rent payments, a landlord may agree to forgive a certain amount of the past due rent if the tenant remains current thereafter.
Loan Conversion. Rather than abating past due rent, a landlord may agree to convert the past due rent into a loan payable over time. The tenant would continue to pay the current rent. The loan is then evidenced by a promissory note that is cross defaulted with the lease.
Due Diligence. When considering a request for rent relief, it is important for the landlord to perform due diligence. The first step is to request and review the tenant’s current and prior financial statements. To the extent possible, the information received from the tenant should be certified as being complete and accurate. The next step may be to conduct an evaluation of current asking rents, common area expenses, and real estate taxes at comparable properties. Thorough Review of the Existing Lease Terms. The lease should be reviewed and scrutinized to see what opportunities there are to revise other lease terms in today’s environment.
Summary. As a general rule, tenants in default should not be entitled to rent relief. However, the reality of COVID-19 may be that you may likely be confronted with this possibility. Such documentation should stipulate that the rent reduction will automatically terminate and revert back to the original rent schedule if the tenant does not pay on a timely basis. Any such document should also include a provision that at the end of the reduced term, the rental rates revert to the original lease terms.
Please feel free to contact me to discuss in the event rent relief modification becomes a reality for your business in today’s environment. Donna Faye Shetley at 864-580-2303 or firstname.lastname@example.org.
It is important to note that many strategies for restructuring leases have the potential of creating tax consequences and, therefore, both the landlord and tenant should consult with their tax advisers.