Seven Steps to Lease Renogotiations
Consider These Factors When Dealing With Troubled Tenants.
In a perfect world, all property owners
and managers would know and understand their tenants' current economic
conditions and future business prospects. Tenants would be able to
predict business slowdowns and use that knowledge to accumulate
financial cushions to survive hard times. And landlords and tenants
would work together proactively to keep lease obligations in line with
In the real world, that is not always the
case. National and global economic conditions change quickly today and
can affect local office and retail tenants unexpectedly. Industry
slowdowns, personal crises, or the location of a competitor six blocks
away can change tenants' fortunes and prevent ordered lease
renegotiations. For a variety of reasons, tenants may not communicate
their real or potential problems to their landlords until it is too
Because every lease term is open during a renegotiation,
the renewal process can be just as complex and time-consuming as
negotiating the original lease. In addition to studying the economics
of proposed modifications, landlords must consider their tenants'
relative economic strengths and prospects, as well as the supply and
demand factors of the markets in which their properties are located.
office and retail lease renegotiations, landlords should consider the
following seven issues as they relate to both struggling and stable
tenants. In each case, done correctly, renegotiations can lay the
foundation for lasting and profitable futures for tenants and
1. Know Tenants' Businesses.
best thing that landlords can do to ensure successful lease
renegotiations is to remain knowledgeable about their tenants'
businesses. This process begins with the original lease negotiation.
Including, monitoring, and enforcing lease covenants that require
tenants periodically to provide financial statements or profit-and-loss
reports keep landlords informed.
Moreover, landlords must pay
attention to tenants' industries. Understanding the business cycle of a
tenant's industry may provide an indication of the health of a tenant's
business. If an industry slows down, such as recently happened in the
technology sector, the tenant's business also may be in trouble.
of tenants' financial conditions can help landlords determine whether
or not tenants that are renegotiating have a good chance of surviving.
landlords must ascertain who the decision maker is in a tenant company.
Often, this is apparent; for example, if the individual who negotiated
and signed the original lease handles the renegotiation, generally it
is safe to assume this individual can make the ultimate decision.
However, considering the number of mergers that have occurred,
landlords may want to begin the renegotiation by asking if the tenant's
negotiator has the authority to make a binding decision. If the
individual handling the negotiation did not sign the original lease and
is unknown, landlords are justified in requesting documentation such as
a corporate resolution that shows that the person has the authority and
power to conclude a deal.
2. Analyze the Market.
informed landlords also must know the area in which their properties
are located, as well as competing markets. If large blocks of space are
becoming available for sublease in the surrounding area or new space is
being completed, tenants that are willing to move can exert some
leverage on their current landlords.
However, if the market is
tight and a tenant can't move to a comparable building for
significantly less rent, the landlord maintains a stronger position.
But landlords also should remain aware of the possibility of tenants,
particularly office tenants, relocating to other cities. Landlords can
ask tenants what alternatives they are considering. The best protection
against this is knowing what it would cost a tenant in terms of time,
money, and disruption to uproot its business and employees to a
3. Consider Decreasing Rental Rates.
most-often renegotiated lease term is the rental rate. The
renegotiation of rent, while relatively straightforward, can cover a
number of issues.
Since the original lease was signed, rents in
surrounding areas either have risen or fallen. A tenant renegotiating a
lease already may be paying an above- or below-market rate. If space is
tight and replacement tenants are available, decreasing a specific
tenant's rent may not be necessary. Conversely, if new tenants don't
appear readily available, renegotiating the rate might prevent the
space from becoming vacant.
If the current rent is well above
the market rate, a landlord may consider compromising to avoid losing
the tenant. However, in exchange for this concession, the landlord may
insist that the tenant lengthen the lease term. In essence, the
landlord trades dollars for stability. This can benefit a landlord
looking to stabilize a property's cash flow for a longer period.
retail tenants, landlords might lower the fixed rent in exchange for an
increased percentage rent. To some degree, this ties the landlord's
fortunes to the tenant's ability to produce revenues capable of
offsetting the decline in fixed rent. An added advantage is that the
total rent will increase as the tenant's revenues grow.
several drawbacks exist for the landlord. These include the possibility
that the tenant's revenues never increase to offset the decrease in
fixed rent, the discount lenders and investors apply to percentage
rent, and the expense and effort necessary to confirm the tenant's
With tenants paying common-area maintenance charges
or a pro-rata share of the property expense, landlords should consider
renegotiating these costs. Tenants paying net lease charges may try to
reduce their expenditures, or at least cap future expenditures, in an
attempt to limit costs. Depending on the future expenses necessary to
maintain the property, a landlord may be willing to allow a tenant to
adjust this number.
In exchange for decreasing CAM charges,
landlords can consider various alternatives. One would be negotiating a
new lower base year, usually defined as the amount the landlord spends
per square foot to maintain the building in a certain year, in exchange
for a higher escalator or higher base year for a lower escalator.
Escalators are the amount by which these charges increase yearly and
can be tied to objective benchmarks such as consumer price index data
or a set flat rate such as 3 percent.
4. Add or Strengthen a Guaranty.
renegotiation is an opportunity for landlords either to gain a guaranty
of a previously unguarantied lease or strengthen an existing guaranty.
a tenant to add or strengthen a guaranty can be difficult. However,
gaining such a concession is valuable if the tenant fails but its owner
retains significant assets. If a tenant's financial condition is
precarious, its owner may close the business rather than personally
guarantee the obligations of a shaky enterprise. Conversely, if a
tenant has a strong financial statement, negotiating a guaranty might
be a sufficient exchange for allowing the tenant to remain in the space
at a decreased lease rate.
If a lease already is guarantied,
renegotiation can provide landlords with an opportunity to strengthen
the guaranty. A landlord can insist on an additional guarantor or
expand the terms of a limited guaranty by lengthening the time a
guaranty remains in place or exposing other assets of the tenant in the
event of a default.
In addition to understanding the tenant's
finances, landlords also must understand the guarantor's finances. It
is imperative that landlords know at the outset how they will collect
any assets due under the guaranty and where those assets are if that
5. Remember Lender Requirements.
who have taken out a loan to acquire or develop a property should
consult their loan agreement prior to renegotiating any lease.
Financial covenants may restrict a landlord's ability to renegotiate
Commonly, lenders require landlords to maintain certain
debt-coverage or loan-to-value ratios. Because both DCR and LTV are
functions of the property's income stream, decreases in income can
cause the property to violate such covenants.
In addition, some
lenders insist on the right to approve lease concessions. In most
cases, lenders will not kill a deal, but may impose certain costs on
the landlord, such as requiring a principal pay down to maintain the
property's compliance with the financial covenants.
6. Consider Tenants' Space Needs.
The amount of space that a tenant occupies often comes into play at lease renegotiation time.
tenant reducing the size of its workforce also may want to decrease the
amount of space it occupies. By doing so, the tenant hopes to limit its
rent payments as well as decrease its pro-rata share of the building's
This potentially presents a landlord with two
complementary opportunities. A tenant with sufficient assets but
foreseeing a need for less space may be willing to buy out part of its
lease. For example, a tenant occupying two floors of an office building
but reducing its workforce so that it only requires 11/2 floors may be
willing to pay the landlord a discounted amount of rent to relinquish
its right for the now-surplus space. After receiving a discounted
payoff from the reduced tenant, the landlord could try to lease the
space to a new tenant.
If a tenant is unable to buy out the
surplus space, it might want or need to sublease some or all of its
leasehold. The lease language may prohibit subleasing or require the
landlord's consent. Many leases reserve a landlord's right to approve
any potential sublessee and permit only specific uses of the property
by both the original tenant and sublessees. Consequently, the landlord
can extract a concessions clause from the original tenant to provide
something of value in exchange for permitting the sublease. The
landlord should take advantage of this clause if it can negotiate a
better deal with the subtenant than the landlord obtained in the
Some leases permit a landlord to reclaim the
space from the prime lessee and re-lease it to the tenant that would
have been the sublessee.
7. Understand Exclusive-Use and Co-Tenancy Clauses.
retail leases contain either exclusive-use or co-tenancy clauses. These
clauses can be renegotiated if needed, but they can make the
renegotiation process unwieldy because adjusting them often requires
the consent of a third party.
Many retail anchors, particularly
grocery stores, drugstores, and movie theaters, require exclusive-use
provisions in their leases. These provisions provide that only that
specific tenant can sell certain types of products in a particular
retail center. When another tenant renegotiates its lease or attempts
to sublet space, the landlord must ensure no violation of an
exclusive-use clause occurs.
Co-tenancy clauses also can hinder
renegotiation attempts. A co-tenancy clause states that a tenant may
close its store or reduce its rent if another tenant or group of
tenants does not occupy space at a retail project or if the occupancy
rate of the project falls below a certain level. If this is the case,
the landlord is stuck and may lose other tenants because of a
co-tenancy clause violation caused by the renegotiation. To avoid this,
landlords should understand and monitor the parameters of these clauses
so they don't breach their leases with other tenants in an attempt to
preserve a troubled tenant.
Many of these lease renegotiation
issues complement each other or can serve as alternatives to each
other. By surrendering a little on rent, landlords may extend the lease
for several more years. By allowing a tenant to sublease space,
landlords may be able to preserve a higher lease rate. Thus, by knowing
the tenant, the market, and the terms of existing leases, landlords can
be ready for any tenant attempting to renegotiate its lease.