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BLOG / 04.27.20 /Kenneth R. Jacobs,Thomas W. SmithandTatiana A. Shestova

Coronavirus: Dealing with Commercial Tenants Seeking Rent Abatements

Many commercial tenants are asking their landlords for rent relief due to their business losses during the lockdown. How are landlords responding?

Spoiler Alert: No Magic Bullet or Standard Formula. We have consulted with landlords with billion-dollar portfolios and with only a single tenant. All of them have advised us that they are dealing with their tenants on a “case-by-case” basis. However, as a general proposition, we suggest that landlords should work with their lender prior to offering any relief to tenants.

Landlord’s Analysis. Both landlords and tenants have the same goal: to survive the lockdown with a minimum of damage, and to maintain fiscal security for the long term. For the landlord, that means covering their costs and making mortgage payments. For the tenant, that means being able to reopen their premises after they are allowed to, and to weather the inevitable ramp-up to pre-lockdown levels. A landlord’s evaluation may include the following:

Has the tenant applied for PPP or EIDL Loans? Tenants with under 500 employees can take advantage of the Paycheck Protection Program, which allows tenants to receive forgivable loans from the government as long as they utilize at least 75% for payroll and the balance for qualified debts, which include rent. Debt that is not forgiven bears interest at a 1% rate and matures in two years. If they get the loan, that should alleviate rent concerns for at least 30-60 days.

Other tenants may be eligible for EIDL loans. These are mostly not forgivable but have reasonable repayment terms and include an emergency grant of up to $10,000 that might be forgiven if it is distributed within three (3) days. NYC also advertises “Business Continuity” loans, but the program has run out of funds.

How much of the tenant’s business is on-line? Some retail tenants also have a robust on-line business that may not have been affected as deeply.

Will the landlord’s lender allow rent adjustments? Most mortgages require the landlord to procure mortgagee approval before modifying a lease to reduce rents. Landlords should check whether their mortgage includes that covenant. The feedback from our clients is that lenders will usually cooperate with a landlord who seeks to preserve its longer-term financial stability by granting a rent adjustment, as long as the landlord is not in default under the loan documents.

Will the landlord’s lender consider mortgage forbearance? FNMA and Freddie Mac have directed lenders servicing or insuring multifamily mortgages held by them to grant a 90-day forbearance (to be repaid over the following 12 months), provided that the mortgagors do not seek to evict or charge late fees to tenants during the forbearance period. Several of our commercial clients have successfully negotiated mortgage forbearance with institutional lenders holding loans in their portfolios. (Note that such negotiations might also include extension of reporting deadlines for financial or other statements or a temporary relaxation of DSCR or other valuation requirements in order to take into account the potential rent reduction.)

Servicers of securitized commercial mortgages (“CMBS” loans) currently are not authorized to grant forbearance. These loan packages face major default risks unless (say) the Federal Reserve decides to purchase them to preserve liquidity. However, some FNMA securitized mortgage pools have been placed in a “forbearance period” (review the FNMA website for more details.) A fuller discussion of the effects of COVID-19 on commercial mortgage-backed securities is beyond the scope of this update.

Negotiation Options. Both landlords and tenants should have a longer-term strategic plan in place to guide their negotiations. Fortunately, as a general principle both parties have a common goal to ensure a profitable business for a good longer-term tenant.

“Blend and Extend.” Unsurprisingly, landlords considering forbearance usually seek a compensatory benefit. For some, this may be an extension of the lease term, which enhances fiscal stability for the owner. Others may seek repayment of the foregone rent over a period of months (perhaps in steps) while business levels return to normal. Landlords also consider elimination of renewal or expansion rights in return, or allowing the security deposit to be used to fund the rent (possibly for replenishment later).

Immediate rent reductions to ensure cash flow sufficient to cover landlord’s fixed costs in the short term. A number of landlords have based the size of any forbearance on the amount that the landlord needs to receive monthly in order to cover its fixed costs. That way the landlord doesn’t fall further into debt, but the tenant receives some relief. This may be harder to calculate for multifamily owners, which have a mix of residential and commercial rents.

Cooperatives and condominiums may have less leeway because they don’t make “profits,” but there may be certain reserve contributions that can be deferred, such as lender-required operating reserves or capital repair reserves. If they have FNMA, FHA or Freddie Mac mortgages, they may also receive forbearance as detailed above.

Would reducing the size of the premises help? Some tenants may not be able to support the full premises they have leased for some time. In that case, perhaps a sublease of a portion of the premises would be feasible. This may seem to be only a band-aid, but that may be all the tenant needs.

Non-Disclosure Agreements. An honest dialogue is essential if a mutually satisfactory agreement can be reached. Some landlords may want detailed information on a tenant’s financials or loan status under the PPP before considering forbearance, or a landlord may wish to keep the details of an abatement confidential if an agreement is reached. In that case, the parties should sign a Non-Disclosure Agreement so that information leading to forbearance stays between the parties.

Modification vs. Forbearance. Conceivably, a temporary forbearance might not be subject to lender consent, especially if it were to be repaid at a later date. Landlords should check their mortgages for the precise wording. On the other hand, if a tenant were to declare bankruptcy, then unless the lease has been formally modified other creditors might seek to claw back money paid to other creditors that otherwise would have gone for rent, claiming a preference. Tenants should consult their bankruptcy counsel in that regard.

Conclusions. Right now the way to deal with the inevitable shortfalls in commercial rent payments remains subject to significant governmental, bank and economic business decisions. We will keep you informed as the landscape shifts.