CRE Rent Negotiations During the COVID Crisis | Resident First Focus

Commercial Real Estate owners and operators have been holding their collective breath: what would April and May 1st bring? Who would be paying rent (in-full or partial), and who wouldn’t?

The COVID-19 crisis had seemingly come out of nowhere. Even the most prepared investors couldn’t have foretold a total cessation in economic activity in the way we’ve observed over the last couple of months. Almost overnight, some residents or tenants with otherwise flawless accounts have found themselves incapable of paying their rent in a timely fashion. 

April 1st gave us some early perspicacity into this woeful situation: Roughly 30% of commercial tenants failed to pay rent on time, notably in the tourist, retail and hospitality-driven markets. The figures vary significantly, depending on the sector of the industry. The retail, office, and hospitality industries, for example, have been especially hard hit. Some of these tenants foresaw that it was going to be messy and didn’t wait until April 1st to let their landlords know that that the rent wasn’t to be expected. Other property types have managed better, expressly multifamily, and industrial, as these product types endure and continue to be in high demand.

Across all property types, owners have engaged in complex rent negotiations as a consequence of the COVID-19 crisis. In this piece, we look at some of the standard rent negotiation tactics that are being employed today.

Rent Negotiation Tactics during the COVID Crisis

The COVID crisis hasn’t affected all tenants equally. Remarkably some businesses are still functioning in full swing, even beyond capacity. This is undoubtedly true at pharmacies, delivery companies, and grocery stores, but it’s also true for many office-based businesses whose employees can work from home seamlessly. Other occupants are operating partially, while some have shut their doors entirely even while continuing to maintain payroll. We believe that relief should be granted to rental property owners and small business owners who suffer similar negative consequences.

The multifamily sector has fared well to date. Rent collections remain strong, boosted by an enhanced unemployment insurance program. The question remains: how long will rent collections remain strong moving forward? We think multifamily residents will continue to step up to meet their obligations because of the services the industry provides them.

May rent payment data reflects a 1.5 percentage point reduction in the share who paid rent through May 6th, 2019, and compares with 78% percent who had paid by April 6th, 2020. The data incorporates a broad assortment of market-rate rental properties across the United States, which can vary by size, type, and average rental price.

Depending on the resident’s situation, they may have asked their landlord for relief. Relief can come in many forms. We’re seeing the following rent negotiation tactics being employed across the commercial real estate space today.

Rent Reduction. Some lessees have asked property managers if they can pay a lessened rent for a piece or all of the duration left on the lease. Some have received credits on their deposits, waived late fees or created rent payment plans. This ensures the landlord secures some revenue, even if it’s short of what the owner/operator would otherwise be owed. Sometimes this is structured as a discount in base rent; for example, in multifamily, some operators are offering a one-time 10% off rent for on-time payments and have seen a great response. Some of the more well-capitalized owners are accommodating residents with a rent relief fund. Other times, retail or hospitality tenants ask for reduced operating expenses. Sometimes they ask for both. In retail, we’re seeing many occupants inquire about converting base rent into percentage rent until restaurant restraints are lifted, and business is back to typical. 

Rent Abatement. There’s a crucial contrast to be made between rent deferral versus rent abatement. Rent abatement, i.e., rent forgiveness, is when the owner allows forgoing rent collection entirely – without penalty or expectation for future repayment. However, we’ve seen this in the retail and restaurant sector, where these ground-floor uses are already a loss-leader for the owner. In many circumstances, these businesses are already so profoundly subsidized (think: the restaurant on the ground floor of a lab building), that rent amnesty costs the landlord little in practice.

Rent Forbearance. Forbearance is when a proprietor provides temporary payment relief to aid tenants who cannot afford to pay given unusual hardship scenarios—in this case, COVID-19. Depending on the structure, forbearance arrangements involve either penalties or interest being added on to the rent owed. That rent, plus any associated fees, are required to be paid back over a period of time (e.g., three-month rent forbearance that is then repaid over the following 12-months). Again, this relief is coming to occupants within retail, restaurant, and hospitality. 

Modification of Operating Clauses. Some occupants have asked their lessors for a temporary suspension or alteration of operating covenants, such as co-tenancy, kick-out clauses, go dark provisions, and/or minimum working hours, etcetera. These conversations are particularly frequent in the retail, restaurant, and hospitality sectors.

Invoking Lease Terms

Both residential and commercial rental agreements will often contain stipulations or clauses that make fulfilling your obligation under your lease agreements paramount. This language is to create an upfront understanding of the two-party relationship, but most often, these stipulations are never invoked. The COVID crisis has landlords looking into their lease agreements and loan documents to descry what recourse may be feasible given the uniqueness of this situation (i.e., a global pandemic). Open two-way communication is vital. When adding a third party to the conversation, the legal fees will likely be more than rent obligations and create difficulty when looking to move elsewhere. 

Here are some lease terms that can be invoked:

Force Majeure. Force majeure, which is French for “superior force,” is a clause used in contracts to allocate risk between parties by relieving obligations under exceptional and/or unforeseeable circumstances beyond the control of the individual parties. Historically, force majeure provisions are seldom invoked. They are ordinarily only utilized in situations where there’s been extreme damage, such as terrorism, floods, and hurricanes. 

However, depending on how the stipulation is written, a pandemic might not be deemed one of the triggering circumstances to enable force majeure. Businesses must critique their contracts thoroughly to see what is included in the force majeure clause. Some agreements include explicit language regarding notice and dispute resolution procedures; owners must comply with these requirements if invoking a force majeure clause.

Common-Law Doctrine of Impracticability and/or Impossibility of Performance. These terms are used reciprocally and ordinarily in contracts where force majeure is not spelled out or otherwise applicable. Impracticability and impossibility clauses frequently cover “acts of God” or acts of third parties that are both unforeseeable and exceed the control of the affected party. For example, retail tenants are referring to these clauses by advancing the argument that the federal shutdown of their operations has made it impractical or impossible to satisfy their lease obligations. Impracticality and impossibility may each establish grounds for termination without liability of the affected party, depending on the contract language and individual circumstances. With malls reopening, driving this discussion becomes less effective. 

Frustration of Purpose. The frustration of purpose doctrine pertains to both the sale of goods and the performance of services and may excuse performance where the partner endeavoring to be relieved no longer has the will to perform. Like the clauses mentioned above, frustration of purpose usually requires the frustrated party to have reached that stage through no fault of his or her own. If the frustration is merely temporary, responsibilities may be postponed but not considered fully terminated. 

Constructive Taking. The theory of “constructive taking” is well-established in case law and could conceivably be applied to select retail and hospitality leases, but it unclear that courts would affirm the argument that a COVID-19 interruption is an act of government that resulted in a partial or temporary taking. 

Material Adverse Changes. Material adverse change (MAC) clauses were called into use during the Great Recession, typically on a lender’s behalf. MAC clauses can also be utilized in transaction documents to give buyers (or tenants) the strength to exit from a deal if they can prove that a MAC has transpired. Legal experts are still opining on if the current COVID-19 outbreak constitutes a MAC, but this has not stopped some from pursuing this strategy when seeking relief from certain contractual obligations.

The Case for Business Interruption Insurance

Many landlords believe that businesses should be able to demand reimbursement under business interruption and rent loss insurance for coronavirus losses. In reality, there are material barriers to overcome that may impede insurance coverage for COVID-19 related losses (namely, that most business interruption indemnification is triggered by “direct damage to property;” a lack of physical damage on-premises will preclude or exclude most claims). However, landlords and tenants are being urged to file claims with their insurers for several reasons:

  1. The insurance company has the onus to demonstrate that there is no safeguard under the policy and is bound to investigate all pertinent matters and conditions encircling a claim.

  2. There could conceivably be governmental intervention or court decisions that force insurers to pay damages as a consequence of COVID-19, in which case it will be necessary that owners have already filed a claim. There are open-ended legislative debates in various states on this matter (including in Massachusetts, New Jersey, and Louisiana). 

  3. The state or federal government may extend a grant program at some point that would compensate businesses for additional expenses and lost revenues due to COVID-19. It is essential to keep meticulous records to support a claim. Any government assistance program may demand proof that an insurance claim has been submitted and denied.

We strongly support providing direct federal rental assistance to families and individuals who suffer a loss of income during the crisis. 

Reasons to Remain Optimistic

Notwithstanding the temporary turbulence in which rent conversations are more commonplace, there’s reason for investors to be confident. Indeed, most investors are optimistic about the long-term probabilities of commercial real estate – particularly multifamily, which remains strong. 

Apartment renters who can meet rent are rising and doing so to avoid the severe and negative impacts on credit. Owners and operators have been reaching out empathically and engaging in discussion to develop creative strategies and flexibility to make the entire ecosystem work. It’s a good story amid COVID-19.

This isn’t unfounded optimism. Already, we’ve seen commercial real estate hold its value relative to the stock market. While yes, it is harder to get deals done right now, commercial real estate investors aren’t panicking. We haven’t seen any significant price adjustments yet, and if we do, industry experts anticipate a drop of potentially 10% -- certainly not the 30-50% pricing adjustment experienced during the last downturn. Those with dry powder are sitting tight for now: they’ve hit the pause button but are preparing to jump in the next three to six months as the economic engines roar up again.