The speed at which the economy stopped in 2020 has put tremendous strain on business owners, impacting landlord and tenant relationships. The Government’s actions to stop the economy in an effort to slow the spread of COVID 19 have closed or otherwise harmed many successful businesses. On one hand, the Tenant has been harmed and may not be able to make the payments. On the other hand, so will the Landlord if the Tenant does not pay according to the terms of the Lease. A similar relationship exists between property owners and lenders. This discussion can be applied in this context as well.

Landlords and tenants seem to be at odds, but their interests are more aligned than is readily apparent. When a Landlord receives notice of a Tenant in distress, at least six options can be considered. . We recommend evaluating each situation and identifying the best solution individually. We also recognize there are laws and contracts in place that impact the decision making process. The context for these options are discussed in the context of commercial real estate, but they can equally be applied in residential real estate or any investment real estate context. Following is a brief summary:

Option 1: Do Nothing

If a Tenant requests relief, the Landlord is not obligated to grant the relief. Although there may be legitimate reasons for the Tenant’s distress, the Landlord is not operating the Tenant’s business and is not obligated participate in the downside. The Tenant isn’t paying additional rent when it is business is exceptionally good, who should the Landlord reduce the rent when the Tenant’s business is exceptionally bad?

Landlords may offer many reasons for not participating. Any of them may be legitimate from the Landlord’s standpoint. One of the most common reasons to say no a request is to simply postpone making a decision. By not agreeing, the Landlord also preserves the option to pursue the Tenant under the terms of the lease agreement.

Tenants are not helpless in this situation. They have the option of simply not paying and forcing the landlord to enforce the terms of the lease or come to the negotiating table.

Option 2: Waive All or Partial Rent

If Option 1 is extraordinarily Landlord friendly, Option 2 is extraordinarily Tenant friendly. If a Tenant requests relief, the Landlord may grant it. From the Landlord’s perspective, it may be much less expensive to waive rent than have the property go vacant, pay leasing commissions and tenant improvements to accommodate a new tenant. In a commercial application, vacancy, leasing fees, concessions, and tenant improvements can easily cost six months of rental income. In a residential context, vacancy and turnover cost may equal one or two months rent. Working with an existing tenant may be less expensive than finding a new one.

Tenants who make a request to waive rent should be understanding of the Landlords challenges. The building owner will also have expenses and obligations to meet and asking for a waiver of rent may create a hardship for the landlord. Understand that any concession granted by the Landlord are not free to offer.

Option 3: Extend the Lease Term

Every Tenant and Landlord expect to renegotiate at the end of the lease term. Sometimes the Tenant willingly vacates. Sometimes the Landlord choses not to offer an extension to the Tenant. Most of the

time, the Landlord would rather have the tenant remain in the space than start over. In these cases, in consideration for waiving all or a portion of a lease payment, the Landlord might negotiate to extend the lease.

The lease extension could be for the amount of time the lease was waived, or for any period of time, longer or shorter. A Landlord might want to get a commitment for an extension of five or ten years in exchange for waiving some rent. On the other hand, a Landlord who wants to change tenants might negotiate to shorten the term of the lease in exchange for honoring the Tenant’s request.

Tenants should recognize that the bigger the rent waiver request, the more the Landlord will expect. Modifying lease terms to be longer (or shorter) may be worth the short term financial flexibility needed.

Option 4: Raise the Rent

A Tenant who needs short term relief may be able to make up the rent payment over time. It could be deferred for a short period of time, or it can be added to all future lease payments—possibly with interest. This is capitalizing the rent. In this way, the Tenant receives the accommodation requested and the Landlord receives the rent earned—with interest for having the payment postponed. While the timing is different than originally agreed in the lease, it is a solution that can be effective for both parties.

Tenants who have a good business and who will legitimately be back in business expect to be able to pay a little more in the future and should be prepared to make the landlord whole over time.

Option 5: Use the Security Deposit:

Many lease agreements have a security deposit. It is common for that deposit to be one or two months rent. A Tenant who has a security deposit in place may ask the Landlord to accept the security deposit in lieu of making a rent payment. This ensures the Landlord has the lease income needed and the Tenant can skip a payment to support their business.

Tenants should understand that they will not receive their security deposit back at the end of the lease term. Further, they should be considerate of the way the space is returned to the Landlord so that the Landlord is not penalized for having forgone the security deposit at the Tenant’s request.

Option 6: Improve the Credit Quality

A Tenant may not have signed a corporate or personal guarantee. The Tenant may have not pledged any collateral at the time of lease signing. Generally, landlords prefer stronger credit tenants to weak ones. With this assumption, a request from a tenant accompanied by an improvement in the credit may be better received by a Landlord.

Tenants often negotiate to minimize long-term credit exposure. This is a situation where if a Tenant wants the Landlord to support its long term business opportunity, the Tenant can lower the risk to the Landlord. A request to waive rent and simultaneously reduce Tenant credit exposure could be seen as a sign of a Tenant’s weakness and incentivize the Landlord to find another Tenant to lease the space.

Conclusion

There are many options available to both Landlords and Tenants facing difficult times. Any of the solutions could be the right one depending on the individuals and situation. In considering these options, it is important to make sure than any adjustment is compliant with loan covenants and in

accordance with government regulations and directives, that differ for residential and commercial property. Also, It is critically important that whatever decision is made, get the revised terms in writing as an amendment to the Lease Agreement. Landlords and Tenants working together should see better results as they work through the range of options available.

NAI Excel, NAI Vegas, and its affiliates manage over $350 million in real estate assets from Salt Lake to Las Vegas and are available to assist in managing Landlord and Tenant relations.

R. Neil Walter, MBA, CFA

Neil is both partner and CEO for Brokers Holdings (NAI Excel). His client base is primarily focused on investment properties, development land, special use assets with or without the accompanying business, and difficult to sell REO properties. Neil’s professional experience is built on a capital markets foundation of deal structuring, cash flow modeling, and asset pricing. He has worked on projects including development land, multifamily and student housing, convenience store portfolios, grocery stores, motel/hotel properties, manufacturing companies, transportation companies, wind farms, farms and ranches, professional service firms, and start-up entrepreneurial ventures. He has advised on transactions with or without real estate.

For nine years, Neil taught economics and upper division finance at Dixie State University. His courses include Real Estate Finance, Entrepreneurial Finance, Financial Modeling and Decision Making, Intro to Economics, and Macro Economics. Previously he priced derivatives and structured products and helped create risk metrics for the North American Gas and Power Trade Floor at ConocoPhillips.