With the COVID-19 shutdown interrupting business operations across a large swath of industries, office tenants have begun seeking rent relief. For example, Kenneth S. Fields, Los Angeles attorney at law firm Greenberg Glusker, says his office tenant clients are asking if they can stop paying rent, and landlord clients are seeking advice on what to do if tenants stop paying.
Whether an office landlord can evict a tenant for non-payment of rent or if the tenant is legally responsible for paying rent during the shutdown depends on what’s written in the lease, Fields notes. So, both parties should review their leases to determine how the documents address the current situation, if at all.
For example, a “force majeure” clause in a lease absolves tenants from paying rent when an “Act of God” or an insurmountable man-made interference prevents their ability to meet contractual obligations, so the coronavirus qualifies as force majeure, according to Fields.
Meanwhile, state and local governments, including Los Angeles, Los Angeles County, New York, King County where Seattle is located and other major cities, have enacted emergency legislation prohibiting evictions of both residential and commercial tenants for non-payment of rent during this economic crisis.
“Tenants have become knowledgeable about their deferral rights under state or local laws and many office tenants large and small are either asking for help or simply not paying rent,” Fields says, noting that office landlords also know the rules and both parties are aware that most courts are currently closed.
However, emergency legislation typically only provides for rent deferral, so tenants must pay the rent eventually, generally over a period of three to six months after the deferral expires. Additionally, an office tenant must be able to establish that the COVID-19 situation actually prevents it from paying rent, Fields says. “This may be more difficult for larger corporate tenants that presumably have larger cash reserves and/or access to capital that allows them to continue paying rent” compared to small business tenants.
“We’re seeing asks for relief from companies of all sizes,” says Nick Axford, global head of research at real estate services firm Avison Young. “Workforce characteristics, industry, geographic location, local market conditions, remaining term of lease, and relationship with the landlord are all factors.”
It remains to be seen how the courts will resolve rental disputes arising from the shutdown, Fields notes. But the situation is already putting stress on tenant/landlord relationships, he says. Landlords rely on rental income to fund their own financial obligations and loan documents most likely require the landlord to obtain lender consent before waiving or deferring a tenant’s rent, he says. An institutional landlord and other landlords with low-debt leverage may be able to bear a larger and longer rent deferral than a landlord with low reserves or a heavy debt load, Fields adds. He notes that some institutional landlords have already offered their tenants multi-month deferrals with payback schedules.
How landlords respond to office tenant requests for rent deferrals or reductions will in part depend on the wording of the lease, but in most cases, it will be a matter of individual judgment as much as legality, and will vary widely, adds Axford.
“The size and financial stability of the tenant, the historic relationship with the landlord, and the landlord’s desire to retain the tenant within the building are all factors considered,” he says, noting that the recent U.S stimulus package did not address this issue. The $850 billion in the CARES Act earmarked for businesses and governments provides federal loans that can be used for payroll, rent or utilities expenses, but those loans must be repaid.
Most landlords will expect tenants to seek help from the Small Business Administration (SBA), rather asking them to bear all the pain, in Fields’ view. Under the CARES Act, the SBA will provide businesses with loans of up to $10 million. But landlords should recognize that tenants who seek Payroll Protection Loans (PPLs) from the SBA will want to do so in a manner that allows for complete loan forgiveness, rather than leaving their company laden with debt when the market begins to normalize, Fields says.
As a result, he advises office tenants and landlords to work together to find a solution that will enable both parties to survive, based on what each is capable of doing under the circumstances. “This is not the time to negotiate for the last nickel,” he stresses.
The day after tomorrow
While it is too early predict the exact nature and duration of COVID-related damage, Axford, who served as a lead author on a recent report titled “COVID-19 Impacts on Real Estate,” notes that the call for social distancing will likely change workplace strategies across the board, from traditional office leasing models to flexible office operators.
“On the flexible side, we anticipate the beginning of a consolidation within the flexible operator community where those positioned for growth will absorb operations of those currently looking at survival,” Axford says. “Owners with (co-working) operators in survival mode could be left with viable flex locations and a decision to make.”
While some may attempt to re-lease these spaces to other co-working operators, there will likely be an increase in owner-operator management agreements with proven operators in existing spaces, he forecasts.
Overall, office landlords should expect some changes in how tenants utilize space going forward, according to Fields. “I expect that tenants with contraction rights will look at exercising those rights, and tenants without contraction rights will investigate subletting space. A landlord should review the assignment and subletting provisions of the lease carefully. the lease will dictate the landlord’s response to tenant sublets, but landlords have the right to demand additional security and/or a share in the profits,” he notes. “And where credit is an issue the landlord should consider obtaining letters-of-credit in lieu of a cash security deposit to mitigate bankruptcy exposure.”
The Avison Young report suggests that the working-from-home experiment during the quarantine may accelerate the remote working movement and increase employee flexible working options. “This time is validating that people can work remotely and be productive,” Axford says. That could lead to a significant shift in how corporate occupiers manage their office portfolios.
“Flexible workspace among occupiers was already a growth driver in the sector, with organizations finding it increasingly difficult to commit to long-term leases. This will only be further impacted as we navigate a recession,” Axford notes.
Office tenants will emerge from this crisis having gone through the largest global experiment ever in remote working. This will likely drive corporate demand for flexible lease terms made available directly by institutional landlords.
“Whether an occupier, operator, or institutional owner, financial projections for 2020 have been disrupted and each party must engage in a proactive approach to mitigate short-term risk and realign long-term portfolio management strategies,” he says.
