As Covid-19 continues to spread and impact every aspect of American’s lives, nothing is more important than our health and safety of that of our loved ones. But some aspects of our lives don’t take time off, and if you operate a business in leased real estate, your lease obligations won’t take hiatus. If you calmly, wisely make the best of this difficult time, you can come out of it confident that you accomplished all that you could for your business and those who rely on it for their livelihoods.
Top Tips to help a business operating in leased space to weather today’s economic storm
Devise a Preparedness Plan
Take stock of your current situation, have a solid strategy, and stay focused. A well thought out preparedness plan tailored to your specific situation can make a huge difference on how you survive now and into what is an uncertain economic future.
Cash is King
Now more than ever, protecting cash-on-hand is key to most businesses. Take the time to look at your historical financials and compare them with your current financials to intimately understand COVID-19’s impact on both top-line (gross revenue) and bottom-line (net profit). Take into consideration natural fluctuations in your business (eg., ice cream shops in winter vs. summer). Rent will likely stand out among the largest jolts to your cash-on-hand.
Structure a Lease Solution
You will want to review your lease and approach your landlord on a solution. Whether through altruism or self-interest, your landlord should be a willing listener. A trusted advisor can guide you through the process.
Step #1- Lease Review
In order to arm yourself for talks with a landlord, and with a pen and notepad handy, pull out your lease agreement and review the following sections:
- Rent: What is the rent comprised of (just base rent or are there pass-through expenses), what are the amounts, and what is the next scheduled increase?
- Lease Expiration Options: When does the term end, what renewal options remain, and what are the business terms of the option (rent, etc.)?
- Default: What constitutes a default of the lease, and what are the landlord’s remedies if that occurs (late penalties, interest, eviction, damages)?
- Guarantees: Outside of your business, who may be liable in the event of default?
- Security Deposit: Does the landlord hold a security deposit, and if so, how much?
- Operating Covenants and Co-tenancy (applicable to retail centers): Are you required to stay open for business, and if so, are specific hours and days required? And for its part, is the landlord obligated to maintain tenants or a certain occupancy-level?
- Insurance: What coverages are each party required to maintain? (Note: insurance coverage is an esoteric thing, and you shouldn’t automatically assume what relevance these coverages have to your current situation; take the information to your insurance agent as discussed below.)
- Force Majeure: Does the lease excuse either party’s performance when outside circumstances intervene?
Step #2- Homework
Don’t look at your lease in a vacuum, and compile the following additional information before approaching the landlord:
- Discuss the possibility of a claim under any insurance policy you or your landlord may carry. This is an important area to explore, because insurance coverage may provide the parties their best recourse. On the other hand, beware that the insurance industry’s exclusion of disease outbreaks from most policies in response to the SARS outbreak in 2003 makes coverage less likely.
- Evaluate governmental relief programs, both fiscal (stimulus, tax relief, etc.) and otherwise (such as any local restrictions on commercial evictions enacted pursuant to Executive Order N-28-20). Borrowing may be an unattractive but necessary alternative, and the Small Business Administration is ramping up lending to address COVID-19.
- Consider consulting a lawyer with relevant expertise to learn what legal options you may have, including those that don’t appear within the four corners of your lease agreement.
- If you are a franchisee, contact your franchisor to discuss what relief it may be willing to provide (or may already be considering internally) to lighten your current financial obligations. Subway is one franchisor that has already announced such measures.
- Take note of how long you have been a tenant in the space, and whether you’ve ever been in default.
- Based on the evaluation of your financial position, decide what a rent concession from your landlord would need to look like in both a COVID-19 best-case and a COVID-19 worst-case scenario.
Step #3- Approach the Landlord
Now that you have done your homework, you are well-prepared to speak to your landlord:
- Contact the landlord (or property manager) to let them know how your business is being impacted and set up a meeting. Come to the meeting prepared with the full array of data outlined above. Enter into an open conversation to identify a solution or combination of solutions that you can both agree upon. If applicable, discuss your success and longevity as a tenant.
- Rent reduction – The most likely solution is a reduction of rent, for a set period of time; the reduction could also be on a month-to-month basis, terminable by the landlord on 30-days’ notice. Reduction may be a deferral, meaning it will be repaid at a later date or over many dates. Or it may be conditional, meaning it will be forgiven as long as you meet some future condition (e.g., exercising a future option or avoiding the commitment of any future default). Or it may be absolute, meaning no repayment or other strings are attached (though some small form of consideration such as a small maintenance obligation should be given in exchange, for enforceability’s sake). To entice the landlord to agree to any form of rent reduction may require a carrot. These may take any form, though some common ones are:
- In the retail world, adding a percentage rent component to the lease, which can be structured nicely using historical sales data.
- In the deferral scenario, adding interest to the future rent repayment obligation;
- Committing to an extended term, perhaps at a generous rental rate;
- Providing the landlord with new security such as a personal guaranty from yourself or a creditworthy “co-signer”; or, even
- Giving the landlord a share of your business.
- There is no limit to the ways a solution might be structured, other than the imagination. Some more of these include:
- Application of Deposit – If the landlord holds a security deposit, and you have been a good tenant to-date, you may ask the landlord to credit it against your current rent obligations.
- Transfer – You might approach the landlord about working with you on a subletting or assignment. This could reduce or even eliminate your rent obligation, and if your space can be shared or subdivided then you could even continue to operate. The landlord could know a potential replacement tenant, or you could find one on your own (or in conjunction with an advisor such as Capital Rivers). If there is an interested party out there, you may be able to make a deal work.
- Buyout – Another option is a lease buyout, meaning the landlord agrees to terminate the lease in exchange for a (hopefully affordable) payment. This may allow you to continue operations at a new location, perhaps after a short hiatus.
- Be armed with the knowledge that for most landlords, losing tenants is very disruptive and costly. Landlords incur major costs in the form of income loss and expenditures such as legal fees, brokerage commissions and tenant improvement costs. They have mortgage payments to make and may have co-tenancy covenants in other leases or loan documents. Worse yet is a tenant bankruptcy, which subjects the landlord to bankruptcy rules and puts control of the lease in the hands of a bankruptcy court.
Difficult, But Essential
As this discussion demonstrates, addressing just this one piece of your business in a time of crisis such as COVID-19 is a difficult task. But the lease obligation is a big piece for just about any business that operates out of rented space, and it absolutely warrants careful attention.
Source: CapitalRivers Commercial