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.
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.
How NAI Long Island Approaches Lease Modification
The article above was written for a moment of extraordinary disruption, but the principles behind a successful lease modification apply in any market. Businesses grow, shrink, merge and change direction. Buildings change hands, and landlords adjust their strategies. When circumstances shift, revisiting the lease is often better for both sides than a vacancy or a dispute.
For Tenants
A lease modification can help a tenant right-size its space, adjust the rent schedule, extend the term in exchange for concessions, or add flexibility such as expansion or termination options. The key is to approach the landlord early, with a clear explanation of your situation and a realistic proposal. Landlords are far more receptive to a tenant who communicates openly than to one who simply stops paying rent.
For Landlords
For owners, a well-structured lease modification can protect occupancy, preserve cash flow and maintain the value of the property. Options may include short-term rent relief in exchange for a longer term, restructuring tenant improvement allowances, or adjusting operating expense provisions. Each change should be weighed against lender requirements and the property’s long-term business plan.
Lease Modification Checklist
- Review the existing lease, including assignment, sublease and default provisions
- Gather financial information that supports your request or position
- Understand current market rents and concessions for comparable space
- Identify what you can offer in return, such as a longer term or a larger security deposit
- Put every agreed change in a written amendment reviewed by your attorney
Our brokers represent tenants and landlords across Nassau and Suffolk counties in renewals, restructurings and every type of lease modification. Explore our commercial real estate services, browse available properties, or contact NAI Long Island to talk through your options. As a member of NAI Global, we can also support companies with locations across the country.