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The Lease You Can Do

By Lydia Bennett, CCIM, and Soozi Jones Walker, CCIM, SIOR

Understanding the different perspectives of tenants and landlords is key to the lease modification process.

By definition, a market disruption is a situation where a market stops functioning regularly, which usually results in a steep, significant decline. The global COVID-19 pandemic that will define 2020 is a disruption like none other. For commercial real estate professionals, one significant concern is the fundamental relationship between tenants and landlords. As economic instability reverberates across all sectors and in every geographic area, leases will be under strain.

Landlords across sectors are faced with difficult questions resulting from tenants under stress. Is forbearance a way to keep tenants in properties? Are rent deferrals a short-term solution to disruptions in retail, multifamily, hospitality, and other sectors?

Pinterest offers one huge example of how quickly things can change in the office market. Back in March, the online giant signed a deal for 490,000 sf of office space in San Francisco, adding up to $440 million in total payments over the life of the lease. Flash forward to August, Pinterest decided to pay the landlord $89.5 million to cancel the contract. In this case, the tenant calculated the discounted value of the office space and decided to negotiate with the landlord/owner to reach an agreeable settlement — one that totaled 20 percent of the $440 million in payments.

Lease modifications will be a hot topic moving forward. To prepare for these negotiations, it’s vital to understand the perspectives of stakeholders so agreements can be made on modifications that satisfy all parties.

When comparing the goals of tenants and landlords in any renegotiation, you first need to understand the goals of each party. Both want to preserve income and continue to be able to pay all obligations. Tenants, though, are hoping to maintain business income and keep control of the location, while landlords are interested in preserving the value of the building and maintaining ownership of it.

It’s also crucial to take a step back and understand that lenders are concerned with the stability of the income stream. A major disruption in the economy, which COVID-19 certain is, can add risk to the loan investment that was not considered when the loan as funded. Other rules and regulations from the Securities and Exchange Commission, Internal Revenue Service, and/or other government agencies can lead to higher loan loss reserves or other ramifications. To minimize increased risk during the renegotiation process, lenders may request:

  • Borrower’s financials for property encumbered by the loan.
  • Borrower’s personal financial statement.
  • Tenant leases including amendments.
  • Tenant financial statements including balance sheets, income statements, and current profit and loss statements.
  • Market study/analysis.

The new reality in commercial real estate includes some significant obstacles, including mandated closures, operating restrictions, increased customer safety needs, and potentially lower profits given reduced capacities.

We are not in a standard market cycle. But the best CRE professionals will recognize opportunities to assist with lease modifications, and understanding the perspectives of everyone involved is a key first step.

Editor’s note:
This article was adapted from the CCIM Institute course, “Lease Modification Strategies and Solutions.” Visit www.ccim.com/education for more information.