Let’s face it, times are tough. Landlords are fighting for tenants and tenants are short on cash, and in the current market where cash is king, everyone can use a little help. This column addresses what landlords and tenants are finding in the market today, along with a few ideas that may help promote mutually beneficial transactions–monetary concessions, downsizing to smaller space and adding “green” components to leases.
At a time when managing cash flow is vital, finding the best value for space tops every tenant’s list. Aside from the obvious reduction in base rent, a few simple alternatives that may help keep a deal alive include negotiating for periods of rent abatement, variations in percentage rent and increased contributions for tenant improvements.
The commercial leasing market is currently seeing an increase in each of these concessions. A landlord who is able to offer periods of complete or at least partial rent abatement is more likely to have tenants vying for its space. To balance these early upfront concessions and resulting lost profits, a landlord could build in more aggressive escalation clauses during the latter years of the lease term.
Many retail leases include percentage rent provisions that may be negotiable in this market. Although landlords have little incentive to remove percentage rent altogether, a landlord’s flexibility may create enough goodwill and favorable conditions to entice a good tenant to renew for another term.
Often parties are able to effectively negotiate a cap on percentage rent, or the landlord and tenant may agree to a “trial period” provision, which provides a termination right if the tenant does not reach certain sales thresholds within a specified period of time. This reciprocal termination provision may appeal to both the retail tenant who is leery of a long-term commitment in this market and the landlord who desires to replace an unproductive tenant.
Finally, some commercial landlords are able to offer generous improvement allowances in hopes of luring tenants. Such allowances help tenants remodel space to meet their specific needs while avoiding a tremendous cash outlay. In many cases, landlords should control construction of the improvements, thereby protecting against liens, shoddy work and other potential liabilities.
Unfortunately, certain monetary concessions are not viable for those landlords that are restricted by bank covenants associated with the loan on their property. These landlords must work even harder to find creative ways to attract tenants.
Now, let’s say a tenant occupies 10,000 square feet in a building with several other tenants. This tenant is forced to lay off half its employees and now only needs 5,000 square feet of space to run its operations. It can no longer afford the rent and other expense associated with the space and is facing default under its existing lease. The landlord has two vacancies in the building, with 6,000 and 4,000 square feet each.
It’s a simple scenario, yet it is overwhelmingly commonplace in this market. By negotiating an agreement to relocate to the smaller space within the building, both parties can benefit–the tenant reduces expenses with less rent, and the landlord keeps a normally good tenant who otherwise might have defaulted. Although the available space may not be an exact match for the tenant’s needs, it may offer a more prudent alternative than default.
Lastly, it seems we are trending toward all things “green”: green buildings, green cooking, green lifestyle. However, despite the increasing buzz, many commercial landlords have not jumped on the green bandwagon. Many believe green building and/or renovations are too expensive, the cost-recoupment periods too lengthy, and they frankly just do not know where to start.
There are, however, a few things that landlords can do now that are comparatively inexpensive, will reap immediate benefits and require little “green” knowledge. Landlords can start with the following: install Energy Star appliances, implement programmable thermostats, utilize “smart” meters for electricity, (if available), replace exterior windows, upgrade insulation, or convert existing lighting to more efficient systems. These improvements benefit both the landlord and tenant alike.
Triple-net leasers could see a reduction in operating costs or common area maintenance expenses, while landlords will have a more efficient building that is increasingly competitive in the market on a gross rent basis. For those landlords who truly desire to make green their goal, there are many ways to modify lease language to incorporate green objectives.
Although the green components in the recent legislation primarily favor homeowners, schools, and federal buildings, energy incentives could eventually trickle down from state and local governments. Currently, there are still some interesting and innovative incentives for commercial landlords, many of which came to pass in last fall’s bailout negotiations. This package brings per-square-footage tax deductions for energy efficient measures and other “green” steps taken. Landlords can qualify for assistance to invest in alternative energy systems installed for onsite power generation. Additionally, green roof installations under the Clean Energy Stimulus and Investment Assurance Act may qualify commercial landlords for a 30% tax credit on qualified expenses.
Despite the volatility of the current market, all is not lost. There are ways for landlords and tenants to work together toward mutually satisfying agreements while still protecting their individual interests. After a careful look to ensure that tenant financial challenges are based on the current economic climate and simply temporary, diligence in creating landlord-tenant fixes is sure to benefit both parties.
Focusing on viable monetary concessions, allowing a tenant to downsize to smaller space and joining the green movement sooner rather than later should allow landlords to attract and keep good tenants. It’s simply about weathering this storm until the skies clear.
The views expressed here are those of the author and not of Incisive Media or its publications.
Courtney Milam is a real estate attorney with Shuffield Lowman & Wilson PA in Orlando. She can be reached at email@example.com.