Monday, March 9, 2009

Calling a Bluff: Lease Renegotiations

For the purpose of leisurely analogy, tenants looking to renegotiate their leases with landlords isn't too dissimilar from the functionality of baseball contracts. Unlike in other sports like football, baseball player contracts are guaranteed for the life of the contract. Owners cannot renegotiate them if a player gets injured, or fails to live up to their previous performance. On the flip side, if a player "outperforms" his contract, he can attempt to renegotiate an extension for more dollars/year or threaten to leave via free agency or demand a trade.

Of course, the economic climate, job loss reports, earnings reports, and major bankruptcy filings like those of Linens 'N Things and Circuit City make it easy for tenants to argue their case. Some landlords are quick to help, figuring that blending and extending their leases gives them more assurance of income over a longer period of time, even if the rental rate has to drop as a result.

So what level of recourse do landlords have when all of their tenants come crying, asking to renegotiate (see: lower) their rent at the same time, giving the threat of bankruptcy (and therefore zero rent payment) if the landlord doesn't choose to work with them?

There are several things to consider before caving:

1. Know Thy Tenant - The best thing that landlords can do to ensure successful lease renegotiations is to remain knowledgeable about their tenants' businesses. This process begins with the original lease negotiation. Including, monitoring, and enforcing lease covenants that require tenants periodically to provide financial statements or profit-and-loss reports keep landlords informed.

2. Know Thy Market - If large blocks of space are becoming available for sublease in the surrounding area or new space is being completed, tenants that are willing to move can exert some leverage on their current landlords. The best protection against this is knowing what it would cost a tenant in terms of time, money, and disruption to uproot its business and employees to a different location.

3. Know Thy Options - Since the original lease was signed, rents in surrounding areas either have risen or fallen. If space is tight and replacement tenants are available, decreasing a specific tenant's rent may not be necessary. Conversely, if new tenants don't appear readily available, renegotiating the rate might prevent the space from becoming vacant. An alternative option to lowering base rent would be renegotiating CAM reimbursements. In exchange for lowering reimbursement requirements, a landlord could negotiate a new lower base year, usually defined as the amount the landlord spends per square foot to maintain the building in a certain year, in exchange for a higher escalator or higher base year for a lower escalator.

4. Know Thy Assurance - Convincing a tenant to add or strengthen a guaranty can be difficult. However, gaining such a concession is valuable if the tenant fails but its owner retains significant assets. If a tenant's financial condition is precarious, its owner may close the business rather than personally guarantee the obligations of a shaky enterprise. Conversely, if a tenant has a strong financial statement, negotiating a guaranty might be a sufficient exchange for allowing the tenant to remain in the space at a decreased lease rate.

5. Know Thy Loan Terms - Landlords who have taken out a loan to acquire or develop a property should consult their loan agreement prior to renegotiating any lease. Financial covenants may restrict a landlord's ability to renegotiate leases.

Know Thy Space Requirements - A tenant reducing the size of its workforce also may want to decrease the amount of space it occupies. By doing so, the tenant hopes to limit its rent payments as well as decrease its pro-rata share of the building's expenses. This potentially presents a landlord with two complementary opportunities. A tenant with sufficient assets but foreseeing a need for less space may be willing to buy out part of its lease. After receiving a discounted payoff from the reduced tenant, the landlord could try to lease the space to a new tenant.

7. Know Thy Co-Tenants -
Co-tenancy clauses also can hinder renegotiation attempts. A co-tenancy clause states that a tenant may close its store or reduce its rent if another tenant or group of tenants does not occupy space at a retail project or if the occupancy rate of the project falls below a certain level. If this is the case, the landlord is stuck and may lose other tenants because of a co-tenancy clause violation caused by the renegotiation. To avoid this, landlords should understand and monitor the parameters of these clauses so they don't breach their leases with other tenants in an attempt to preserve a troubled tenant.

In addition to these seven commandments, its also wise tor remember one other thing. Odds are that a tenant's prospective bankruptcy is going to hurt them a lot more than it will hurt the landlord, and often its a case of absolute last resort. Giving the appearance of helping a tenant is usually enough, and in the process, you can garner many of the advantages, or at least offset a decline in rental income, by taking some of the approaches listed above.

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