Protect Your Interests in Rent Relief Exchanges

Given the current state of the economy, it is not surprising that tenants struggling to stay in business are resorting to rarely used negotiation tactics to ride out the downturn. Specifically, there has been a rise in rent relief exchanges, in which owners temporarily reduce rent for tenants in exchange for taking back certain lease rights the tenants would otherwise be entitled to.

In theory, rent relief exchanges seem logical and easy: trading monetary reductions for nonmonetary, yet valuable rights. But don't think of a rent relief exchange as a simple transaction that helps your troubled tenant; it has financial consequences that could be damaging for you if it is not carefully negotiated.

Structure a Deal You Can Live With

If a tenant requests that you reduce its rent, be cautious about whether you can afford to cut rent outright, especially if your own financial situation is questionable. If you decide that the trend towards rent relief exchanges works better for you, your first step should be completing “due diligence—the process through which you will evaluate your tenant and its finances—with the guidance of your attorney.

Part of the due diligence process is determining how you are going to structure a deal with your tenant. Deferments, especially partial rent deferments, which last from only three to 12 months and have expedited repayment schedules, are a frequently used option. Locking tenants into longer-term leases is another option, but works only in very specific circumstances. The financial statements and detailed business plan you collect during due diligence will help you make an informed decision.

Consider Rent Relief Risks vs. Benefits

Negotiating a rent relief exchange with your tenant is just as serious as entering into an original lease agreement, because there is a change in your tenant's risk profile that you considered—and found acceptable—in the original negotiation.

In fact, your risk will always increase when you give rent relief. When carving out the structure of the deal, mitigate as much of the risk increase as possible by using a tenant strategy that you should have in place to deal with these situations, says Peter Morris, senior vice president of real estate management services with Colliers International, a global real estate services firm. Your strategy should look at: (1) each tenant's role in your commercial property; (2) the legal aspects that apply to it (must you keep it because of a co-tenancy clause, merchandising, or another reason?); and (3) its financial effect on your property. This will identify which tenants are “keepers,” and you can evaluate each request accordingly. “Some requests are justified, some are required, some are beyond hope. And in some cases, it is just a tenant attempting to re-trade to a lower rent in hope of chasing the market down,” Morris notes.

Asking these questions is crucial because the answers will reveal if the business can even be saved, he stresses. “It may be of no use to reduce rent on a business that is doomed anyway.”

What specifically caused tenant's request? Citing the economy is too broad an answer, says Morris. It could be that its credit line was reduced, its latest stock wasn't shipped because the supplier unexpectedly went under, or something else unique to its business, but you need to know, he advises.

Is this a short- or long-term problem? This will give you an idea of how much help your tenant will need, and for how long.

Who else is supporting tenant or reducing its costs? You probably are not the only creditor who has been asked for a deal and is considering reducing its price. But if no one else has agreed to help the tenant, you should be worried. You also should set your percentage of relief at roughly the same number as that of other suppliers that are cooperating.

How will tenant use rent savings to change its situation? The goal of the rent relief exchange is for the tenant to get into a better financial position so it—and, consequently, you—don't have to deal with a bankruptcy. There absolutely has to be a plan to recover from the situation; otherwise, the deal is pointless. Ask your tenant how it will use the money to improve performance—for example, a retailer could increase marketing for its store.

Ask for Valuable Concessions

The core exchange requirement: A business plan from your tenant that proposes a solution to its problems and outlines how it will be carried out through the entire rent relief period. Of course, by taking a risk on your tenant, you can recapture valuable rights that make the effort worthwhile.

Keep in mind the following concessions that you may want to get during negotiations, based on the nature of your tenant's particular business.

Recapture retailer's rights. In the majority of cases, you should ask your tenant to give up options in its lease that could affect your shopping center's occupancy level. Give yourself more flexibility by recapturing options for early lease termination, exclusive use agreements (so that you can bring into the property a potentially viable new tenant that is competitive with the conceding tenant), or co-tenancy clauses (which can drastically reduce rents for your entire shopping center if a key tenant decides to leave).

Consider service exchange with office tenants. You certainly can negotiate traditional recapture concessions, but office tenants have some advantages over retail tenants in the additional types of concessions they are able to make to you. Exchanging services, such as a law firm offering its legal services to you for rent reductions, is a low-risk concession that doesn't compromise any lease rights and would save you from having to pay an outside firm. Of course, you should accept service concessions only if they are as or more valuable than your tenant's lease rights.

Seek important relief concessions from any type of tenant. Whether you are dealing with a retail or office tenant, the following concessions will mitigate the risk you are taking on your deal:

• Get a conditional surrender either ongoing for the balance of the term or during the relief period, allowing you to obtain control of the premises with reasonable notice if you find a replacement tenant or otherwise need the space. However, think about letting your tenant stop the process by repaying the total amount of relief.

• Initiate immediate termination and repayment of relief upon a material default during the relief and repayment periods.

• Get additional security, such as a personal indemnification or promissory note for the relieved rent.

• Reduce the amount of the requested relief by giving the tenant temporary merchandising flexibility. Allow it to add a non-conflicting use to its existing use to boost sales.

• Accelerate relief repayment in addition to (not as a replacement for) a defined repayment program. This mitigates your risk during the repayment period.

Despite Reducing Rent, Still Come Out Ahead

When taking advantage of the lease contract being opened for a rent reduction by renegotiating other aspects of the deal through concessions that benefit you, be flexible but calculated; this is a large negotiation that may take time and several meetings. And engage professional real estate, accounting, and legal advice. You need all three, not just one or the other, Morris emphasizes. Helping your tenant with a rent relief exchange can be a win-win situation, but only if it is not at your own expense.

Insider Source

Peter D. Morris SCSM, SCMD, CLS: Sr. Vice President of Real Estate Mgmt. Services, Colliers International, 865 S. Figueroa St., Ste. 3500, Los Angeles, CA 90017; (213) 532 3276; peter.morris@colliers.com.

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