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The Commercial Real Estate Market in the Time of COVID-19

Part One – Negotiated Solutions to the Commercial Landlord/Tenant Relationship

This is the first in a series of alerts that will provide guidance on various topics related to the business considerations and the rapid evolution of the Commercial Real Estate Market as a result of COVID-19

Modifying  the Relationship

Managing the landlord/tenant relationship during the time of COVID-19 and the resulting economic downturn will require careful strategic planning and increased dialogue. Unlike the pre-pandemic period, where a strong economy drove increased land and rental values, the post-pandemic period will see both landlords and tenants struggling to maintain healthy cash flow and capital reserves.  While most commercial landlords and tenants have now considered their pressing tenancy issues as a result of the nationwide shut-downs, they have yet to address their relationships going forward to ensure continued occupancy or the termination of same. In a prior alert [click here] we outlined the relationship and relative rights of landlords and tenants.

This posting will focus on two potential courses of action to address the landlord/tenant relationship as a result of the post-pandemic world.  One avenue will discuss maintenance of the landlord/tenant relationship and the other will discuss the termination of relationship.  Both seek to avoid needless legal expenses and litigation costs.  These two options are:

  • Negotiated Lease Modifications; and
  • Negotiated Lease Terminations

Negotiated Lease Modifications (“NLMs”)

When Should Landlords Consider a Lease Modification:  For obvious reasons, landlords and tenants have a mutual interest in maintaining a tenancy.  Landlords have debt-service obligations and in many cases, lender-imposed occupancy ratios.  Tenants’ businesses require optimal use of the leased premises.  The current economy has impacted all sectors - some positively, like warehousing, and some catastrophically, like the restaurant industry.  There are certain sectors, however, that have a reduced need for leased space, but still need to maintain a physical footprint.  Legal and accounting firms are just two examples.

For those tenants who are forced to reduce their work force commensurate with reduced market demand, a reduction in square footage may allow them to utilize the leased premises optimally as they did prior to the pandemic.  In situations where a tenant’s business will continue to operate, but not on a pre-pandemic scale, it is in the best interest of the parties to work toward a negotiated solution through an NLM.  The parties could consider a reduction in a tenant’s monthly rental obligations, but this would not “optimize” the usage of the leased premises.  The better option is the reduction of the tenant’s leased premises footprint.

Although reduction of a footprint will necessarily reduce a tenant’s monthly rental obligation, it will avoid the legal expenses associated with the eviction of a defaulting tenant and resulting litigation to recover monetary damages.  Additionally, a landlord will “free-up” square footage that it can re-let to a new tenant that may also be experiencing a need for reduced space.

Further, the immediacy of the negotiated solution will preclude any need on the part of the landlord to mitigate its damages by finding a tenant able to occupy the entire lease space.  In this scenario, the tenant reduces its leased premises footprint and the landlord has options available to address the rapidly evolving market.

An NLM is preferable to the termination of a lease for both the landlord and tenant because it will permit the landlord to maintain a revenue stream while the tenant maintains a physical work-space.  In the event a tenant’s business is in the “catastrophic” sector mentioned above, however, a lease termination may be the only option.

Negotiated Lease Terminations (“NLTs”)

When Should Landlords Consider a Lease Termination:  A landlord should consider an NLT for those tenants whose business operations have been catastrophically altered as a result of the pandemic.  Restaurants are the most obvious example, but movie theaters, retail locations, and group gathering places, like bowling alleys, are other examples of businesses that will have a very difficult time surviving once the “restart” occurs.  In this situation, a tenant has come to terms with the fact that it will no longer have a need for the leased premises.

In this scenario, if a landlord chooses to take a hardline position, opting to evict a tenant and pursue monetary damages through litigation, the resulting expenses and time spent may outweigh the ultimate recovery.  As with NLMs, NLTs will allow a landlord to avoid legal expenses and the effort associated with attempting to mitigate its damages.  Perhaps most importantly, a landlord who chooses to pursue an NLT will be able to realize capital quickly by negotiating a payout from the tenant at the time of the termination.

In most cases, the tenant will be a limited liability company or a corporation which may choose to file for bankruptcy protection.  Even in those instances where a landlord has obtained a personal guaranty from one of the tenant’s individual owners, the landlord will still need to take steps to collect on the guaranty.  These steps will include the filing of a claim and ensuing litigation.  In addition, and as with most things, time is the enemy.  No rational actor would accept one million dollars if the payment period was one hundred years.  With litigation comes uncertainty and even strong claims are susceptible to effective opposing counsel and court delays.  If possible, it should be avoided.  An NLT will serve this purpose and allow a landlord to obtain the best deal quickly with certainty of outcome.

Conclusion

Knowing your rights and determining your relative bargaining strength has a significant effect on the ultimate outcome in the negotiation of a compromise between landlords and tenants..

For more information, contact Rich Angowski, , (908) 624-6293.