Founder and CEO, Visual Lease.
Since the start of the Covid-19 outbreak, commercial tenants have fallen behind on rent payments as cities across the U.S. have been on full or partial lockdown for months on end. Even as businesses enter various phases of reopening, many are still facing the financial fallout of the closures. As a result, ongoing negotiations and disputes between tenant and landlord over rent payments owed have reached an all-time high. In addition, commercial tenants, especially those hit hardest like retailers, restaurants, fitness centers and movie theaters, are looking for ways to rethink their payment structures and lease agreements for a future that may look drastically different.
To Pay Or Not To Pay?
Suspending rent payment is one option amid a list of financial measures that cash-strapped companies are exploring to sustain their businesses. Most landlords, on the other hand, consider these payments mandatory, as outlined in the terms and conditions of existing lease agreements. For example, one major retail landlord sent a letter to tenants at the start of the shutdown stating “all tenants will be expected to meet their lease obligations,” even as most of the operator’s malls were closed.
Despite this expectation, about 40% of national retail chains skipped rent in May, and landlords didn’t fare much better in June with only 68% of chain retailers paying their rent, according to Datex Property Solutions. Major brands such as Bed Bath & Beyond, Gap, LA Fitness and others paid partial rent or skipped payment altogether.
The rent debate is not isolated to major retail and consumer brands. We polled several hundred companies across financial services, healthcare, energy and utilities and more about the impact Covid-19 has had on their real estate leases, and 30% reported that a vast majority (more than three-quarters) of their leased properties were unoccupied following forced shutdowns. However, 69% reported paying at least a portion of rent on their unoccupied properties. With respect to unoccupied properties, more than 40% said they had not been proactively approached by their landlords to discuss rent relief, but more than half were planning to ask for concessions to their commercial leases, such as rent abatement, deferral or reduction.
While some landlords have been flexible and open to negotiating the terms of their tenants’ lease agreements, others are playing hardball as they face their own ongoing obligations to lenders, and the drop in rent collections has limited their ability to pay bills, taxes and vendors.
As both sides seek relief, the chasm between landlord and tenant continues to widen and multimillion-dollar lawsuits have made their way to court. A number of companies, including Victoria’s Secret (paywall), have filed lawsuits in an attempt to break lease and stop rent payments on agreements they no longer consider enforceable. On the flip side, landlords such as mall operator Simon Property Group have filed counter-suits against companies they accuse of “taking opportunistic advantage” of the pandemic to avoid paying overdue rent.
Look To The Lease: A Framework For Negotiation
The financial losses incurred by both parties may be just the start of a ripple effect that has the potential to alter the commercial real estate market for years to come. Commercial tenants are taking a hard look at their expenses and evaluating their leases for cost savings or specific language releasing them of their financial obligations under these new circumstances. Landlords are looking to this same language to hold renters accountable.
For some, the terms of the lease agreements may serve as a framework to address the economic challenges faced by both parties and open up negotiations. However, even if landlords and tenants fail to see eye-to-eye on responsibilities under the current agreements, we will certainly see more attention paid to how leases are worded and executed in the future.
For starters, future leases may include more specific language in order to protect both parties in similar scenarios. Clauses that are likely to attract greater attention include inability to occupy, force majeure (which protects parties from fulfilling certain obligations when unforeseen circumstances prevent them from doing so), casualty, interruption of essential services, condemnation and more. For example, force majeure clauses may start to specifically include pandemics, diseases or public health crisis provisions, which are not commonly captured today. In my experience as a former leasing attorney, many of these clauses are ambiguous, allowing landlords and tenants to offer varying interpretations of who is responsible.
In addition, we will likely see a shift away from longer leases (10-plus years) in favor of shorter contracts with more flexible terms as gun-shy companies become hesitant to commit for fear that they won’t be able to make their payments, or even need the space, should additional shutdowns occur. The growing trend toward remote work will also limit the need for companies to sign long-term, expensive leases for office space. Given the current economic climate, more than 60% of our survey respondents indicated that there would be changes to how they approach leasing assets, including 30% that already plan to reduce commercial office leases and 30% planning to reduce facilities leases.
Despite companies withholding rent payments, the true impact on the market may not be felt for another one to two years (or more) as many leases are not yet set to renew and early termination may not be an option. In the meantime, every responsible tenant and landlord should carefully study the specific terms and underlying legal principles governing the agreements that they’ve made. Regardless of the terms, it is in the best interest of landlords to be flexible on payment plans and lock in near-term income rather than risk long-term delinquency from a financially unstable tenant or spaces sitting vacant due to bankruptcy. By working together to find a mutually agreeable solution, both parties can exit the partnership at a time that works for everyone and allows the landlord to find a new, financially sound tenant.