Over the past several months, the COVID-19 health crisis has affected everyday life in a magnitude that is hard to fathom. Routine tasks, such as going to the grocery store or walking the dog, suddenly necessitate precautions like face masks, social distancing, and excessive amounts of sanitizer. Unemployment is near record levels, businesses have shuttered, and most of us are confined to our homes to avoid further spreading the COVID-19 disease.
Yet while most of us have adjusted to the “new normal” and cities and counties begin to reopen, it’s hard not to think we’ve hit just the tip of the iceberg in terms of how this crisis will affect our lives for many years to come. Federal, state and local jurisdictions have adopted aggressive measures to mitigate the potentially disastrous effects, including direct stimulus checks and forgivable loan programs, but these programs will expire soon. When these funds are no longer available and the new post-COVID-19 reality sets in, all of us will need to reassess both our personal and professional circumstances.
Landlords and tenants are no exception. While the Paycheck Protection Program and other federal funding options helped many tenants survive the initial few months of the crisis, these tenants will continue to struggle to pay rent long after their funding has been used. Landlords are left in a difficult situation – evict the tenant (assuming no moratoria apply) and spend months searching for a new tenant, or provide relief to the tenant in an effort to maintain occupancy until the economy recovers.
There are many approaches for providing rent relief, each of which has both advantages and disadvantages for landlords seeking to preserve their rental stream and minimize their losses. These options, of course, are subject to any other landlord commitments such as loan covenants, reporting obligations, and other financial requirements. Below are some of these options:
For many landlords, abatement of rent for one or more months represents the quickest and most straightforward option to provide relief for a struggling tenant. Doing so offers a tenant the prospect of removing what is often a primary expense and, for tenants that can continue to operate, hopefully building up sufficient revenues to resume paying rent the following months. Moreover, tenants often perceive rent abatements positively, potentially strengthening the landlord-tenant relationship going forward. Landlords must weigh these benefits against waiving rent that is otherwise properly due and payable under the lease without any prospect of repayment.
Often the most practical option, deferring rent allows a landlord to offer immediate relief to a tenant without actually sacrificing the payment of rent. Whether with interest or not, deferred rent can be spread over a period of several months or the remainder of the term in regular monthly, quarterly or annual payments. While many enactments permitting repayment preclude late fees or interest, nothing prevents a landlord and tenant from agreeing to include such additional amounts to offset the benefit of deferred rent. Unlike rent abatement, this option ensures payment of all rent, with landlords simply bearing the cost of the time value of money.
In lieu of abating or deferring rent, a landlord can abate or defer other costs for which a tenant is otherwise responsible under the lease, such as operating expenses, insurance, taxes and the like. For landlords with loan obligations or other reporting requirements which mandate certain rent thresholds, offering other monetary concessions provides tenant relief without jeopardizing important landlord commitments. These concessions represent hard costs incurred by a landlord, however, so their forgiveness is not often a much better alternative absent a specific reason for preferring payment of rent.
Blend and Extend
Landlords and tenants wanting to provide rent abatement without sacrificing the total amount due under a lease can instead elect to extend the term of a lease in exchange for a rent credit. This option, often referred to as “blend and extend,” provides a longer rental stream for the landlord in exchange for immediate rent relief for the tenant. For many landlords, the prospect of a longer tenant commitment may afford additional value justifying the credit to the tenant. Landlords must also consider that this option sacrifices potential rent during this extended period from the existing tenant or a third-party tenant.
A common approach to rent relief immediately following the start of the COVID-19 crisis involved application of a tenant’s security deposit to rent immediately due and requiring replenishment at a later date. While this alternative maintained cash flow for a landlord, it often merely delayed a tenant’s eventual difficulty in paying rent. Rather than seek security through a deposit, sophisticated landlords prefer to seek actual collateral, personal guarantees or letters of credit from their tenants in exchange for immediate rent relief. This right strengthens a landlord’s position if the tenant ultimately fails and breaches its lease. Of course, relying on additional security suggests an eventual tenant default and lease enforcement, a prospect landlords generally like to avoid.
When financial concessions are impractical, landlords may prefer to seek other benefits with respect to their leases which confer value for the landlord. This may include removal of early termination rights, rights of first refusal, options to extend or other rights originally granted to a tenant to complete a lease transaction. While these rights may not immediately offset the loss of rent, the concessions otherwise received may ultimately offer greater benefit for the landlord.
In evaluating the above strategies, landlords would be wise to require a tenant requesting relief to adequately demonstrate financial hardship. Many opportunistic tenants have seized upon the current situation to seek rent relief despite consistent or improved revenues. A shrewd landlord can often stymie these tactics by demanding the tenant provide ample financial records and information, including prior year financial statements, tax returns, sales reports, and bank statements, showing that the tenant cannot satisfy its leasehold obligations. If a tenant has received financial assistance from a federal loan relief program, the landlord should require those funds be paid toward rent to the extent permissible.
Regardless of which approach(es) a landlord may pursue, landlords must be careful to condition such relief on a tenant’s full performance of all remaining obligations under its lease. A landlord offering relief is not in a better position after doing so if, a few short months later, the tenant defaults, leaving the landlord without a tenant and with less rental income to collect via enforcement. It is critical for landlords to preserve all of their rights and claims under a lease while acting in good faith to assist their tenants during this difficult time.
Like their tenants, landlords must adjust to the new reality presented by the current COVID-19 health crisis. With a practical, reasoned approach, however, landlords can minimize the unwanted effects attendant with a pandemic and assist their tenants survive without unnecessarily forgiving a substantial portion of their rental income. If you would like assistance preparing lease amendments addressing these issues, the attorneys at Weintraub Tobin are here to help.