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Helping tenants through rough times.

If real estate is riding the slow loop of an economic roller coaster these days, so are many tenants. The econny has slowed many retail tenants almost to a screeching halt: October 1991 retail sales showed an increase of only 0.59 percent over October 1990-the lowest increase in a 20-year period (Census Bureau Advance Monthly Retail Sales Report). Christmas 1991 failed to reverse this trend.

Many tenants in tough situationswhether retail or office-can pull through with the help of a plan you can offer. And in finding ways to help distressed tenants survive, you can often build a much stronger financial position for the office building or shopping center you manage.

Why do it?

Rescuing tenants in distress is not the traditional role of the property manager. But the phenomenon is becoming more common, as is the scenario in which lease terms make an overwhelming difference to a tenant's survival. How is it possible to help distressed tenants and at the same time strengthen your own position? And why is this more beneficial than losing the tenant?

A key concept is partnership. In shopping centers, the idea is implicit: many leases are percentage-based, and helping tenants usually means helping ownership. Maximizing the synergy in a tenant mix and the traffic flow in a shopping center is vital. The last thing anyone wants, after all, is a dark store.

Gary Hutchinson, CPM(TR), of Oliver Realty/Grubb & Ellis in Washington, D.C., says that the same concept applies in office management: "There is no building without a tenant--then it's only brick and mortar, and the bank owns it." Avery Clenney, CPM, of Brentwood Properties in Birmingham, Alabama, states, "If you have a 40,000square-foot building and a tenant with 92 percent occupancy, you're partners. It's imperative to figure out what you can do if that tenant has problems"

In addition to the time to re-lease space in today's markets, legal fees, leasing agents' commissions, and the costs to refit tenant space weigh heavily when you compare renegotiating a lease to finding a tenant. Especially with retail space, prospective tenants view space that has been "closed" in a very negative light--and they will usually want a rate that is lower than the one the former tenant was paying.

If you have a tenant who is one or two months behind with the rent, you know that to re-lease the space in the market will take up to a year, and you will have to pay a leasing commission equivalent to five months' rent, you are probably better off renegotiating the lease with the current tenant.

Getting informed

There are, however, many scenarios in which you will not want to keep a tenant in trouble-or renegotiate with a tenant who claims there is a problem. The first step, if a tenant comes to you for help, is to decide if the tenant actually needs it.

Explains Joseph E. Borger, CPM, of Borger Management, Inc. in Washington, "There's a perception today that anyone can go in and renegotiate a lease. When a tenant comes to you for a lower rental rate, they might actually have the ability to pay their current one. You have to determine if there really is a problem, or if the tenant simply heard that someone else had a lower rate."

Furthermore, he states, when tenants are in a tough spot, they often don't know exactly what they need. "They come to you and say, 'I need relief.' It's up to the manager to define this and find out what the problem really is.'

There are cases in which, from the outset, you should not rescue a tenant. Says Borger, "We will not keep a tenant when we know that whatever we do will not be enough."

Barring the scenario of an owner in financial straits, the decision to renegotiate with a non-problematic tenant who is experiencing financial difficulties boils down to this: Will the tenant ultimately survive with your help?

According to Jack Gallagher, CPM, of Shannon & Luchs in metropolitan Washington, D.C., "The moment you make a decision to help a tenant, you have established that they are creditworthy and that they're going to make it. The first step is analyzing who you have; is the tenant going to survive?" If you determine that the tenant is a lost cause, it is much better to cut your losses than to have a restructured deal collapse 12 or 18 months down the line.

In some situations, the tenant's survival may very well depend on the deal you offer. This is especially true for tenants who have been hit hard in the current economic climate. States Borger, "The lease may be the sole reason the tenant is having problems, especially if the tenant is in a services industry. In many cases these tenants have already cut payroll and benefits. The rent may be their single largest expense. You can make or break that tenant."

Borger further explains that the tenant's problems may stem from the timing of the lease. In the '80s, both owners and tenants thought rates would increase, so tenants wanted long-term leases. Now, rents have remained flat or even decreased. If you have a tenant in trouble in this scenario, he says, "Compare the costs to re-lease the space and you would be foolish not to make a deal. If you can make certain abatements that allow the tenant to survive, by all means go forward."

The key to the decision is having the appropriate information. The first piece of information you need is the tenant's current financial statement, certified by an accountant and signed by the company's chief financial officer. Of the data found here, the company's cash position is the most important-its collectibles, for example, may be unserviceable. And if the tenant has no assets remaining, you are better off finding another tenant as soon as possible.

A factor to consider in deciding whether or not to work with a small tenant who is self-employed is the amount of money the tenant is paying him- or herself. States Avery Clenney, "If the owner of a small computer company that owes you $1,000 per month in rent is paying him- or herself $5,000, you're not going to be willing to give an abatement"

Also look for the amount of the tenant's debt, how the tenant ran into difficulties, and evidence that the situation is temporary. Reasons for problems that are only temporary include loss of a contract or situations in which an important buyer of the tenant's products changed its way of operating and the tenant needs time to adjust.

You also may want to request a credit check. You should inform the tenant of your intention, but you do not have to ask the tenant's permission. Some managers suggest asking the tenant at this time, however, if there is any information it can provide the management company before it proceeds with the credit check.

Intangibles such as the type of business and its plans for the future are equally, or, in some cases, even more important than financial statements. You should ask: Is the company a service? How directly is it affected by the general economic climate? Who are the individuals in charge and what are they like? How is the building match? Is the company a high-profile business in a low-profile building? Does the tenant have a realistic plan to turn the situation around?

Managers agree you should know everything you can about the tenant's business. In some cases, states Hutchinson, your knowledge should even include gossip that circulates in the brokerage community. You should keep your eyes and ears open to the segments of the business world in which your tenants are involved by reading the appropriate literature. For a government contractor in the defense industry, for example, you would look closely at moves by the Pentagon and the firms that win bids for contracts.

As Joseph Borger explains, "Financial statements are only a snapshot in time. You really have to look at the big picture." He describes a situation with a long-term tenant who was a lobbyist in the tobacco industry. While current financial statements from this tenant provided a rosy picture, the tobacco industry looked like a dying business.

The management company confronted the tenant by asking, "What are you going to do to survive?" The tenant presented a business plan that was well conceived and relied on marketing its services to clients other than tobacco companies. Because the plan was credible, the management company decided to give the tenant a time window of a year to change business direction.

Management forgave increases of all types-from operating pass-throughs to base rental increases-for a 12-month period. In addition, it reduced monthly charges by 20 percent over the period and amortized this amount over the remaining term of the lease. The plan worked, and the tenant is now repaying the abated portion of the rent.

If you stay in close touch with your tenants, it is much easier to obtain the type of information you need-and tenants are much readier to inform you of any problems they have. One way to remain informed is to require the staff member in charge of inspecting your buildings to ask tenants how they are doing. Your staff member should be alert to a reduction in staff or other signs of difficulties.

Tenants who are willing to share information are much more likely to have only temporary difficulties. According to Clenney, "If a tenant is hiding information, it is time to get suspicious. It means it is not willing to pay or the problem is too serious for negotiating." Furthermore, he says, if a tenant comes forward with a plan instead of missing a payment, the company is much more likely to work with that tenant than with the tenant who misses a payment and starts avoiding telephone calls.

Solutions you can offer

Once you have determined the creditworthiness of the tenant and made the decision to help, the next step is negotiating a solution. For this, there are no hard and fast rules; each tenant is an individual case.

One general principle, however, is that of give and take. Always look for ways to help your tenant and at the same time strengthen the owner's position. Perhaps you can offer a financial concession in return for the removal of an undesirable lease clause.

"In one case," reports Clenney, "we had a tenant with 100 percent occupancy in two buildings. The tenant had negotiated cancellation clauses in the original lease. In return for a decision on our part not to activate rental increase provisions, the tenant agreed to remove the cancellation clauses."

One way to help a distressed tenant is a lease renewal wherein some of the current rent is forgiven. It is very rare, even in today's markets, for an owner to offer "free rent" during the lease term with nothing in return. You might be able to offer a distressed tenant free rent for a short period of time with a payback due later, or a restructured lease in which the tenant makes some kind of concession. The possibility of offering this solution obviously depends heavily on the financial position of the owner.

States Jack Gallagher, "In today's markets, it is not uncommon to see one month of free rent for every year of the lease. When you consider getting a new tenant with six to twelve months of free rent over the lease term, and you consider a current tenant who owes two months of rent, you might want to forgive some of this rent if you can restructure the deal and get them to sign a new lease that is manageable."

Downsizing could be part of the deal. "It's better to have a tenant with 10,000 square feet of space that is current and can pay than a tenant with 15,000 square feet that owes you money," Gallagher says. In cases such as this, you also can look for a tenant in the building who wants to expand to the space of the downsizing tenant-it just might be possible.

Not all owners prefer reducing a tenant's leased space, however. Problems with the configuration of the space or an undue burden on the owner may preclude this as a solution. Owners may prefer reducing the rental rate to reducing the leased premises.

Lowering the rate and relocating the tenant might be an alternate possibility. An office tenant with space directly facing an elevator, for example, might move to corner space in return for a lower base rent.

An owner also might be willing to lower a rental rate in return for an extension of the lease. Joseph Borger describes a tenant with a lease that was to expire in 36 months. In return for cutting the rental rate to a current market rate, the tenant agreed to extend the lease for 36 additional months. The distressed tenant was happy with the immediate reduction in rent; the owner was happy that a steady income stream was in sight for the six years ahead. In addition, the concession created goodwill on the part of the tenant.

"If paying the rent is a significant burden for the tenant," Borger says, "and the rent you are receiving is above market, when you compare the costs of re-leasing the space, then bringing the tenant's rental rate down to a market rate is an easy decision." He recommends adjusting base rentals rather than pass-throughs because operating expenses are out of the owner's control.

Allowing a tenant to sublet some space also might be possible. While the sublessee would deal directly with the tenant (who would not relinquish any of the lease obligations), you can help the tenant by having your agents refer prospects to them. You could also offer help with the subtenant's move-in.

In helping a tenant find a subtenant, try to match tenants and subtenants, thereby offering support to your tenant and enticement to prospects. For example, if a law firm gives up 5,000 square feet of space, direct a complementary business such as a court reporter, stenographer, or deposition taker to that space. A title company that would use a portion of the law firm's services would also be appropriate. Other examples are a computer company or a financial management company for space given up by an accounting firm.

Sometimes it is possible to work out alternative payment plans. For example, if the tenant is faced with a contractor who has not paid, you can obtain a consignment letter from the tenant. In return for forgiveness of rent, the tenant agrees to sign over the payment when it comes in. You do not "buy" the contractor's debt; you simply obtain a promise of payment.

Another concession you may be able to obtain from the tenant is personal liability as opposed to corporate. If the tenant is a large corporation, there is usually no personal liability at the outset. Or, with a retail tenant, you may have inherited a lease that includes no protection clause at all. Now you can include it as a prerequisite for a financial concession. In other cases you may be able to extend a personal-guarantee clause that is about to expire.

As an example of a restructured deal that worked well, John P. Estes, CPM, of the Royce Asset Management Group, Phoenix, describes a restaurant in an office building that was a vital amenity. The restaurant was well recognized by tenants and tenants' clients. Some clients even identified the building by the name of the restaurant. Its sales, however, were significantly down. The restaurant's owners came to the management company to report they were going out of business.

Management decided to offer financial concessions in return for a strong amenity the restaurant was leasingan outside seating area with a pond. The restaurant stood to lose nothing by releasing its rights to the space, and the management company could rent it to another tenant.

Important in negotiating with a retail tenant might also be an exclusive-use clause. By offering a lower base rent, you can often get the tenant to agree to cancel an undesirable use clause. You might then be able to rent space to a new tenant you were blocked from obtaining earlier (for example, a bakery that sells ice cream), and still keep an old tenant in place (a frozen yogurt store, for example, which will not actually be threatened by the bakery).

Another option is to direct the tenant to banks or lenders willing to extend credit or to guarantee the rent for a period of time. If you have a defense contractor, for example, who will not see any income for a year, at the end of which it receives the fee for a large contract, require this tenant to have a loan from a bank to pay the rent, or a letter of credit stating that the bank guarantees any rent in abatement.

One creative option is to accept service in kind. A law firm or an accountant, for example, might do legal or accounting work for the owner in exchange for forgiveness of one month's rent. This option requires a "good faith effort" on everyone's part. "The biggest pitfall is that these tenants are usually on an hourly pay scale," Gallagher says. "So, what justifies the hours?" He suggests that any work that is usually paid hourly become a flat fee on a per-case basis, or that you enforce strict accounting for the work. "You don't want the tenant doing work for one and a half months' rent when only one month was at issue," he explains.

Tenants with a cyclical cash flow pose special challenges. Retail tenants in particular are more susceptible to market fluctuations. Relates Borger, "We had a blueprint business whose sales volume was off by 50 percent. But our feeling was that the business was cyclical. The company's lender decided that its reorganization and cost-cutting were significant, and the owner decided the same. We gave the firm a window of nine months and accrued a percentage of the rent over the remaining term of the lease. The firm pulled through and started making repayments this fall."

In some cases you can tie higher rental payments to periods of greater cash flow. Ronald L. Goss, CPM, of RPM Management in Little Rock, describes a sporting goods store whose business was extremely slow in February, March, and April, but went wild in July and August. lt was able to negotiate double rental payments for high cash-flow periods in return for free rent in low ones.

Another way to help retail tenants is to support a remodeling project. Goss describes a long-time retail tenant whose sales had dropped significantly and needed a brighter image. The management company paid for some of the remodeling costs of the store with reimbursements accrued in future rents.

Dropping the base rent for a retail tenant might actually allow you to negotiate a much stronger position for ownership in the future. You might be able to drop to a low base rent but with a step-up agreement. If the tenant's sales go over a specified amount, the base rent jumps to a new level.

Paul Falbo, CPM, of the Royce Asset Management Group explains, "Because the value of any project depends on base rents rather than percentage rents, you are in a much stronger position when the situation turns around."

Decreasing the base rent, introducing an unnatural breakeven point (one that is higher than the natural break point so that the tenant does not start paying percentage rent until its business has turned around), and increasing the percentage rent at this time also are possibilities. When the tenant begins reaping higher profits, both parties have gained.

Basing a retail tenant's rent only on a percentage of sales might be the best solution for a troubled tenant in a shopping center faced with widespread problems. Says Estes, "In a shopping center where the anchor folds and the tenants are dying, a tenant paying no rent might even be more beneficial. At least, you might try putting the remaining tenants on a percentage-of-sales basis. Thus, their proportional costs of operation stay the same regardless of decreased sales. It just might keep them afloat." And it just might keep the shopping center on course until you find a new anchor.

Conclusion

Troubled times hit both tenants and owners. Helping one often means helping the other: a viable but downsized tenant not only contributes rent but allows you to avoid downtime, leasing and legal fees, and the high costs of refitting space. In an office building, an ally within the walls can only be beneficial. And in shopping centers, warm bodies beat dark windows any day.

Dorothy Walton is a freelance writer based in Chicago. She was previously a developmental book editor for the Institute of Real Estate Management. She has also designed and taught courses in English as a Foreign Language in Madrid.
COPYRIGHT 1992 National Association of Realtors
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Walton, Dorothy
Publication:Journal of Property Management
Date:Mar 1, 1992
Words:3515
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