Scott A. Fisher and Abe J. Schear
If you are a retail landlord in today’s market, you are reluctantly answering any phone call, e-mail or other tenant communication. That caution is realistic because you may justifiably believe that every communication from a tenant is a request seeking a rent concession.
A year ago, a landlord would generally have likely met a tenant’s request for a rent concession with rejection and perhaps scorn. Rental rates were stable, if not rising, and tenants were plentiful, or so it seemed. Unfortunately for landlords, times have changed. Rents are falling, replacement tenants are fewer, and landlords are determined to maintain occupancy. As a result, tenants are literally lining up at their landlords’ doors seeking rent concessions. Some tenants aren’t even asking and, notwithstanding that it is a default, are simply sending in reduced rent with a note that they need to immediately “reduce occupancy costs.” Landlords are trying to resist this troubling trend, but are increasingly being forced to acquiesce to this new reality.
The purpose of this article is to provide landlords with a checklist, which outlines key issues that should be considered in connection with tenant requests for rent concessions. While each circumstance will be different, the checklist should focus a landlord on issues applicable to each rent concession request it is evaluating and assist the landlord in deciding whether and how to respond.
Upon receipt of an initial request for a rent concession from a tenant, the nature of the specific tenant could dictate the strategy in handling a request for a rent concession. While a landlord may make a concession to a local tenant in order to preserve that tenant’s ability to continue to remain in business in the landlord’s shopping center, a landlord might not, absent the threat of bankruptcy by a national or regional tenant, make a similar concession to a national or regional tenant which has the ability to pay full rent notwithstanding the performance of the store in landlord’s shopping center. A landlord’s reaction to a concession request might also be affected by the number of leases that a particular tenant has in its portfolio. A concession to a single store tenant is very different than a concession, which has a domino impact.
Another issue that is relevant to a landlord’s initial reaction to a concession request is the source of the requested concession. If the request is coming from a third party consultant versus the tenant itself, it could reflect a larger corporate strategy that may be more difficult to reject or negotiate. Furthermore, a written request with supporting documentation should have more significance to a landlord than a phone call which may merely be a tenant probing for landlord’s willingness to consider a rent concession.
In order to formulate a response to a tenant’s request, the landlord must assess the amount and length of the concession and balance that against issues that create landlord leverage, such as lease guaranties, the tenant’s investment in its space (dollars and/or good will), the desirability of the tenant from a co-tenancy standpoint, and the availability of a replacement tenant. In all cases, the landlord must require a tenant to justify and document its requested concession with current sales reports, financial statements and, ideally, sales tax returns. In this environment, many tenants are going to request rent concessions regardless of whether they have actually been adversely affected by today’s economy. The landlord needs to be diligent in obtaining and reviewing data that specifically relates to the performance of the tenant’s operation in the landlord’s shopping center.
Once a decision is made to grant the concession, there are a number of considerations to be taken into account in finalizing the terms of that agreement. The landlord needs to decide whether it wants to proceed with a formal amendment or to merely acquiesce to a reduced rent. Generally, the formal amendment will be preferable unless an amendment triggers a lender consent requirement, which might otherwise be avoidable. The landlord must look closely at the terms of its loan documents to determine the circumstances under which its lender’s consent is required and accurately evaluate both the availability and avoidance of that consent. In this environment, it may be difficult for a landlord to get a timely response from its lender for consent to a requested rent concession. If a landlord does not execute a formal amendment and wants to avoid a rent concession from being subsequently and permanently included in its lease by a court, a landlord needs to put the tenant on notice (in a manner dictated by local law) that its acceptance of partial rent is not a lease modification and that the landlord reserves the right to exercise its rights for the failure of the tenant to pay full rent, including asserting a default and seeking the collection of the unpaid portion of the scheduled rent.
Two other items that must be emphasized in negotiating any rent concession are the inclusion of (i) a reinstatement right in the event a tenant subsequently defaults after being granted a requested concession and (ii) the right of landlord to terminate the tenant’s lease if landlord locates a replacement tenant. The reinstatement right requires a tenant to immediately pay to landlord any deferred or reduced rental in order to cure any post-concession lease default. The right to replace the tenant protects the landlord if the market changes or the landlord locates a higher paying or more desirable long-term tenant.
An often overlooked issue is the extension of an existing lease guaranty. If a significant concession is made to a tenant, it is not unreasonable for a landlord to require a lease guarantor to extend its lease obligation so that the landlord gets the full economic value from the guaranty. Absent an extension, the value of a lease guaranty may be diluted by any period of reduced rent. Similarly, in order to recapture value being lost in connection with a rent concession, a landlord should consider requiring a tenant to accelerate the exercise of any option or to simply extend the term of the affected lease.
As part of any negotiated agreement, the concession should be conditioned on the benefited tenant keeping any rent concession confidential. While such a provision will not necessarily prevent word from spreading to other tenants, it may discourage a tenant from affirmatively encouraging other tenants in a shopping center to seek similar relief. A significant liquidated monetary penalty (e.g., $10,000 or more) may discourage inappropriate conversations.
In conclusion, the willingness and ability of tenants to seek and receive rent concessions in this market is unprecedented. While each circumstance will be different, the attached checklist and the foregoing discussion should help landlords make informed and well thought out rent concession decisions.
— Scott A. Fisher and Abe Schear are partners in the real estate practice at Arnall Golden Gregory in Atlanta.