Leasing

Coping with Marketplace Shifts

By Bill Scarpino |

With the economy no longer on a long-term growth trajectory, retail real estate users and providers must reassess how they do business. Several significant changes already have occurred. For example, lenders are now more actively involved in transaction approval. They are less willing to fund tenant build-out allowances. As a partial result, tenants are finding expansion cash either hard to get or expensive, and landlords are finding tenants less willing to accept “build-it-and-they-will-come” projects.

Landlords and tenants share one common threat: lenders who want to control the negotiation process to protect their interests. Typically lenders are risk adverse. This is an anathema to landlords and tenants for whom risk is calculated into their business models. This dichotomy presents an inherent disconnect in how the three entities approach a business opportunity.

Exploring Options

Both landlords and tenants should fight lending practices that hinder their ability to conduct business. Increased government oversight has forced lenders to actively avoid risk. Lenders will want more control over borrower’s activities, but these restrictions can force poor decision making on the part of both landlords and tenants. The end result can be mediocre performance or outright failure.

To effectively fight unduly restrictive lease clauses, tenants always can walk away from the table. If a lender is forcing the issue, ask the landlord if the tenant representative can meet with the lender personally to present the tenant's case. If the tenant is financially able, there might even be the possibility for the tenant to provide the landlord financing to circumvent the lender.

When the lease is signed and has commenced, landlords have little incentive to provide additional help to a tenant. This has always been the case. Today this is aggravated by the fact that landlords have little left in reserve. Since 2008, tenants have repeatedly leaned on their landlords for help just to keep the doors open. And landlords have helped.

Now many landlords are literally tapped out. Moreover, they are close to violating their loan covenants. Facing such strong headwinds, can tenants expect to solicit support from their landlords when such help is needed? The simple answer remains ”yes.” Landlords and tenants have a vested interest to work together. But the process is more difficult now. The success rate will be lower and the tenant consideration for relief will be more costly. And tenants must be creative with incentives to enable landlords to work with them and justify their actions to their lenders.

Tenant Approach

When tenants run into difficulty, they need to adjust their way of operating to make ends meet before approaching anyone for assistance. And landlords must do the same thing. After the last two years of adverse economic turmoil, real estate practices have changed. The tactics and techniques of real estate practitioners on both sides of the table must evolve to meet today’s new challenges.

Before tenants approach landlords they should:

• Get their house in order. Tighten their operations and be able to demonstrate that they have taken such steps to the landlord.
• Study the landlord's situation and develop scenarios illustrating how they will be impacted by a closure. Then use this information to forge compelling proposals for assistance.
• Think outside the box. One creative option is to consider buying the property back at a discount, thereby monetizing the asset for a struggling landlord. The property can then be resold on better lease terms or placed in inventory.
• Before making an offer to extend a lease or exercise an option, always review the lease terms that impact the long-term value of a leased parcel with an eye to negotiating more flexible terms. Upgrade those lease terms that facilitate redeployment if the site becomes operationally marginal.

Landlord Actions

Similarly, when tenants approach landlords the landlords should:

• Determine if the tenant has made significant changes in operations to warrant outside help. Review profit and loss statements. Tenants should be willing to provide them on a confidential basis. One objective in this review is to see if tenants are viable.
• Before responding to a proposal, study the tenant's corporate situation to see if there are other locations in trouble in your portfolio or if they may want to occupy vacant space you may have in other locations.
• Think outside the box. Are there concessions this tenant can make that will help you with other vacancies or tenants, either in this center or any location?

Tenants seeking rent concessions will likely meet with strong resistance. But there is no reason not to approach landlords for concessions to assist in remodels or refurbishments, compensate for lease extensions or the exercise of options, or any other lease change that adds value to the leasehold estate or the center as a whole. More than ever before, this is the time that landlords and tenants should find ways to work together to strengthen their relationship.

Bill Scarpino is a principal with Huntley, Mullaney, Spargo & Sullivan, a lease and debt restructuring firm. Contact him at wscarpino@hmsinc.net. For more on how corporate real estate users must adjust to new market realities, read Scarpino’s Investment Analysis column, “The Big Picture,” in the March/April 2011 issue of Commercial Investment Real Estate.