Source: Larry Green, Esq. You have no more good ideas about how to stop taking on water. You are too busy plugging leaks and bailing the flooded mess. Until the consuming public regains confidence in itself, you can't depend on increasing revenues. Relief, if any can be found, must come from reduced expenditures.
There is little else you can cut without compromising your reputation, the quality of what you deliver or your standards of service; in short, your business. Still, you have to do something.
Too many tenants believe that putting their heads in the sand will solve all their problems, and they always seem to find out too late that an unflattering negotiating posture yields little value. So why not just ask your landlord for some help? Before you do, however, take a deep breath and remember that your landlord is your business partner, not your adversary.
See the World Through Your Landlord's Eyes
Your success and that of your landlord are interwoven pieces of the same quilt. The lease you share represents a business deal: It only makes sense if it works for everyone. Why should your landlord care about keeping you in business? From a purely economic vantage point, for his own self-interest, of course. Consider the following:
Cash flow. Retail property owners look for profitability not just in terms of appreciation, but also positive cash flow. When a project does not generate cash flow sufficient to satisfy the owners' debt and other obligations, their internal rate of return is negative, something no one in business wants. Your landlord wants you in your space and paying rent. A vacant space wreaks havoc on cash flow, because expenses do not go away, even when revenue does.
NOI. Cash flow also affects the property's net operating income (NOI). NOI represents the income the property generates minus recurring operating expenses, given an assumed vacancy rate (usually 3 percent to 5 percent.) To value the property, the NOI is divided by a market-driven capitalization rate (cap rate) measured as a percentage. For example, $1.5 million (NOI)/5 percent (cap rate) = $30 million (the value of the property). Thus, any reduction in cash flow decreases the NOI and the property's value. For example, assume the NOI for the property is $1.5 million and that you pay rent of $5,000 per month ($60,000 a year). If your space is vacant, the NOI drops by $60,000 per year to $1.44 million. Dividing that by an assumed 5 percent cap rate yields a value of $28.8 million. So, if your landlord allows your space to become vacant, the property loses $1.2 million in value -- a big deal. Any cap rate increase likewise increases the cost to the landlord of your space being vacant.
Lenders. Lenders often require their borrowers (the landlord) to maintain debt service coverage ratios of 1.2:1 (often higher), meaning that the property must generate income no less than 120 percent of the debt service obligation. Even a small income drop can place a property that is not full close to the permitted minimum.
Other tenants. Other tenants, perhaps a bit on edge about their own financial circumstances, are the first to know when one of their own goes under. Landlords who intervene help do a lot to reduce the prevailing fear level.
Overall effect. The businesses in a center depend on each other for customers. A retail customer might decide to grab a bite to eat in an adjacent restaurant before heading home, just as someone out for lunch might visit a retailer to see what's new. When a tenant fails, the draw to the center is reduced and can be magnified if the public perceives the center as a failing one.
Litigation. No landlord wants to chase a tenant through litigation to get paid.
When to Ask and How
Now that you understand that the landlord is motivated to help you, when and how should you ask? Sooner is better and always before you are in trouble. As with anyone who is owed money, landlords want to know that a problem exists before it becomes unmanageable. It is much better to ask for help than help and forgiveness.
For example, retail tenants of one of my best clients waited until they were $11,000 in arrears before contacting him, their landlord, to ask for help. It would have been much smarter and to their advantage to let him know while their rent was current that they were having problems and during the next month (before their rent became due again) that they would work with him to find a solution. They were fortunate, but only because my client has a heart of gold. They got a temporary one-third reduction in rent and favorable terms on which to repay their arrearage, a deal that saved them, for now. Still, had they not asked, their business almost certainly would have failed.
Probably the best way to contact your landlord is by letter, since landlords often are too busy or removed from the day-to-day operations of the property to field and respond effectively to a tenant's telephone request. Most delegate those types of responses to property managers or in-house administrative personnel. Sending a letter by certified mail, return receipt requested (or overnight courier such as FedEx) more often than not ensures that your message (eventually) will get into the right hands.
You only have one chance to make a good first impression, so take your time preparing your letter. Proofread it. Twice. Have someone else proofread it when you're done, not only for errors, but to see if it explains your points as clearly as you believe you have.
Your letter should be complete but short, and set out your proposal simply. If you ask for a rent reduction of 25 percent, explain how, given your existing revenues and expenses, and the fact that revenues may decline further, you will be able to meet your commitment. Provide real numbers to support your position. No one likes to make a compromise only to have their deal partner return shortly to retrade it. Don't ignore arrearages: If they exist explain how and when they will be paid. Acknowledge that the relief requested should be reviewed periodically to confirm whether it is working or, if not, what more can be done. Propose a solution, don't just ask for or demand help.
Explain what you have done, how you have attempted to increase revenues and reduce expenses, what you have done to raise or borrow additional capital and, most importantly, why what you are proposing will succeed. Avoid being clever or vague -- this is a business matter; your letter should be direct but polite. Be honest and, above all, don't blame the landlord for your economic situation. Landlords understand that these are difficult economic times; but remember, they are at least as difficult for landlords as they are for tenants.
Before you ask, do your homework. Call retail commercial real estate brokers in your area and find out what terms are being offered to retail tenants for leases such as yours. If a landlord can get $3 per month per square foot for a property you are leasing for $3.50, you are less likely to be successful in a request to reduce your rent to $2.50 month. The same analysis should be applied to each term you propose to negotiate. Know not only what your partner expects, but what your competition does. Skipping this step shortchanges no one but you.
The Kinds of Relief You Might Request
Each lease and the economic circumstances of every tenant are different. There really are no limits other than reasonableness and fairness for the types of relief you can request. As you consider what might work best for you, always consider how your request "will play in Peoria" -- will the landlord view what you are proposing as a meaningful attempt to reach a balanced compromise or self-serving overreaching? Be prepared and willing to accept a temporary fix rather than a permanent modification. If things get better, the landlord will want to return to the original business deal it made.
1) Rent. Often the biggest concern to any tenant is economic distress. In the example above, the tenant who came to my client leased about 1,500 square feet at $2.25 per square feet per month ($3,375 per month). We agreed on a temporary basis, to be revisited in six months, to reduce the base rent by one-third to $1.50 ($2,250 per month), saving the tenant more than $1,100 monthly, an amount that is meaningful to them given the circumstances they face. It was not the $1.35 that they proposed, but was only 7 percent more (a reduction of 33 percent vs. the reduction of 40 percent requested) and just $250 more per month than they had offered. Like these tenants, you are unlikely to get everything you request, but if you are as reasonable as they were (and are lucky enough to have a landlord who, like my client, understands the reality of these difficult economic times), you may find that you get more than you expected. Keep in mind that this is a zero-sum game: For every dollar in cash flow you gain, the landlord loses that same dollar.
2) Lease term. If you are fairly certain that your business cannot weather the storm, but want to make good on the promises you made when you signed your lease, consider asking the landlord to shorten the remaining term of your lease by a period that you can survive and that is long enough to give the landlord an opportunity to fill the hole that you will leave in the property. If you believe you will see daylight at the other end of the tunnel we are in, consider agreeing to extend the term of your lease -- increasing your commitment to the landlord -- as a gesture of goodwill, recognizing that the best lease modifications are those representing legitimate compromise. The same analysis should be applied to any remaining option periods.
3) Premises area. Depending on the configuration of your space, adjacent spaces and the entire property, the landlord might be receptive to allowing a reduction in size of the leased area. If you lease 2,500 square feet at $3 per square foot per month but only need 1,500 square feet, the landlord might be willing (if able) to lease the 1,000 square feet for which you are paying but do not need, saving you $3,000 per month. If the landlord agrees, you may be asked to pay for the space until it is relet. Negotiate for a reduced rent, perhaps 50 percent from the time you vacate that space. Some but not all landlords will be receptive since as their tenant, you still are their business partner.
4) Transfer. Revisit with the landlord the terms on which you can assign (transfer all of your rights and obligations in) your lease or sublease (transfer possession of some or all of the leased premises without release from any lease obligations). If you are able to assign the lease, depending on the creditworthiness of the substitute tenant, the landlord may agree to allow you to walk away without any further obligations. Some landlords require a lease termination or other transfer fee to cover administrative expenses and to minimize the risks to the landlord that accompany accepting a new tenant. Be reasonable in negotiating any such fee; a landlord who requests it is not necessarily being unfair. If you are able to sublease all or part of the premises, your obligations under the lease will continue and you will become a sublandlord responsible for collecting rent and other lease charges from the subtenant. The landlord will not have a direct relationship with the subtenant, but will look to you for full performance.
5) Arrearages. You should offer and be prepared to pay what you owe. The landlord is not a bank and did not agree to underwrite your business losses. My client agreed to allow his tenants to pay arrearages of $11,000 over the life of the lease. He gave them one year without any payment and then four annual payments of $2,250 and agreed to carry the loan, which is really what it had become, interest-free, provided that the tenants performed all the terms of their lease, including making all payments. Do not expect a deal this good; it was the exception, not the rule. It is an example of what is possible and that a landlord and tenant, as business partners, can work themselves out of a tough situation by agreeing to work together and make real concessions.
Ask For, but Don't Expect…
As long as you are modifying the lease, you can ask for, but should not expect to get, a prospective annual cap on common area maintenance fees (CAMs), even if temporary, coupled with a request that the landlord defer maintenance and capital improvements until economic times improve, and a "go-dark" provision, i.e., the right to terminate your lease without penalty if an anchor tenant ceases operations. These should be considered to be, and treated as, the "oh, by the way" throw-away items that they are, but it never hurts to ask.
But Don't Even Ask For…
Two lease terms that you should not ask to modify unless your circumstances are exceptional are the elimination of any personal guarantees and a reduction in your CAM charges. It is unrealistic to expect your landlord to release you from personal liability when your business is staggering (that's why you asked for help, remember?) and CAM amounts are budgeted real dollars that the landlord has to spend, often for the benefit of all tenants, including you, for landscaping, security and property management. The landlord's costs don't go down just because your revenues have declined. Asking the landlord to give up some profit to help you is one thing; paying your bills for you is quite another.
Concessions to Consider
Remember that the road on which you will travel is bi-directional. Your landlord, rightfully, will expect concessions from you, beyond your renewed promise to perform.
1) Guarantors. You may be asked to sign a personal guarantee if you have not. You may also be asked to bring a third-party solvent guarantor to the table. Consider carefully before you make a decision to agree to any of these requests. Advice from an attorney always makes sense and should be considered in connection with any lease modification. On this issue, legal advice is essential and should not be overlooked.
2) Allowances. Consider giving up your right to periodic landlord contributions such as future tenant allowances (new carpet, paint, etc.). The savings to the landlord will be real and can offset some of the concessions you are asking the landlord to make.
3) Economics. The landlord may request that you pay an additional month's advance rent or increase your security deposit. Both are designed to reduce the landlord's risk. You should consider each and propose that the increases be paid over an agreed period of time, perhaps three to six months. The landlord could ask that, in addition to your reduced base rent, you agree to pay percentage rent once an agreed sales threshold is crossed. For example, suppose that your business has revenues of $30,000 per month, reduced from $50,000 per month, and that you have requested a rent reduction of 25 percent from $3 per square foot per month to $2.25 on premises of 3,000 square feet, saving you $2,250/month. You and the landlord could agree that for each month your revenues exceed $35,000, you pay a percentage such as 15 percent of the excess, subject to a cap of $9,000 total rent. The thresholds, percentages and terms all are negotiable, of course, because of the complexities involved in defining revenues (What happens to returns? Can credit card charges be subtracted?). In these cases, legal advice is a must.
Traps to Avoid
A few thoughts to keep in mind, to avoid being snared by traps of your own making:
Don't overnegotiate. Do not posture or threaten nonperformance. You might just find that you have talked yourself out of your lease, particularly if you already are in default.
Don't overpromise and underperform. Make a deal you can keep, then keep it. The landlord agreed to find middle ground -- don't take advantage. If you know you can't make things work, accept responsibility for that reality. Do not make your problems, which already are the landlord's problems, any worse.
Don't agree to too much. Always get legal advice before you consider agreeing to a default, confession or stipulated judgment or any other remedy in which you give up more rights than is prudent.
Unquestionably, economic times are difficult, but as long as you do not let your emotions cloud your business judgment (never an easy thing to do), you may find not just wisdom but also comfort in Mark Twain's advice: "Do the thing you fear most and the death of fear is certain." Profitability and a good night's sleep may be no more than a letter to your landlord away. Sleep on it and, if it makes sense, you may just find that the something that you need to do is less fearful and much easier than you thought.
