The COVID-19 global pandemic has wreaked havoc across the country on industries ranging from local restaurants and retailers to health care systems.
State and local stay-at-home orders caused businesses deemed non-essential to close their doors to customers to further public health efforts. Office workers shifted to a work-from-home model. Health care systems limited surgeries and procedures to protect capacity for COVID-19 patient care.
The real estate industry has also taken a direct impact from the COVID-19 pandemic.
Brick-and-mortar retail businesses are not suffering alone. Most other commercial real estate sectors, including office, hospitality, multifamily, restaurant, personal services, entertainment and construction have all been battered since the pandemic began. The economic pressures resulting from the public health measures have tenants of all types looking to landlords for rent relief or simply failing to pay monthly rent and/or operating expenses.
The financial toll of the economy on tenants has resulted in reduced rental income and a corresponding financial strain for landlords.
Lease provisions provide negotiation framework
The terms of the lease document provide the framework for addressing any economic challenges between a landlord and a tenant during these unsettling times.
Tenants should evaluate the lease terms to negotiate with landlords to push for rent abatement or possible termination rights. Force majeure provisions excuse a party’s nonperformance when acts of God or other extraordinary events prevent a party from fulfilling its contractual obligations.
In the context of COVID-19, a more tenant-favorable force majeure clause would specifically include events such as “pandemics,” “diseases” or “public health emergencies.” However, these have not commonly been included in force majeure provisions in the past. In addition, most force majeure clauses do not excuse financial nonperformance (i.e. the obligation to pay rent and/or other expense obligations of the tenant under the lease).
Casualty provisions may include the possibility of rent abatement for tenants
In some instances, lack of access may be tied to a casualty event, and the tenant may be entitled to rent abatement. However, these provisions have generally been limited to situations where the physical structure of the building and/or premises has suffered damage. Since this is a novel circumstance, it has not yet been determined whether contamination constitutes physical damage.
Most casualty provisions in current leases will not provide for any abatement in a pandemic situation. Larger national credit tenants undoubtedly had more leverage to negotiate lease terms that could work in their favor.
However, the pandemic is such an unprecedented situation even the leases with larger national tenants may not provide a framework for any negotiations with the landlord.
Similarly, landlords should review lease provisions to confirm whether tenants have the ability to withhold rent if services that a landlord must provide under a lease, or access to the premises, are curtailed or eliminated. Some of these abatement provisions will apply only to situations where the loss of use is caused by a landlord’s failure to satisfy some obligation. The parties should evaluate whether such language is broad enough to cover any situation where the tenant loses the ability to access or use part of its premises due to circumstances—many of which are outside the control of the landlord.
Limitations on landlords’ ability to negotiate
We recommend that parties, both landlords and tenants alike, open up the lines of communication as soon as possible if they haven’t done so already. Landlords may be amenable to rent extensions or forbearances in an effort to prevent leased premises from going dark.
As the parties weigh their options during negotiations, they must take into account the pandemic’s current and future impact on the tenant’s business. Landlords should consider requesting a range of information regarding a tenant’s financial condition and status: bank statements, recent profit and loss statements, financial statements and tax returns.
Landlords will need to evaluate tenants’ plans and ability to continue to operate and resume paying rent in the near and long term.
Notwithstanding a desire to negotiate more favorable terms for tenants, in many circumstances, landlords may need to have discussions with their own lenders before any substantial tenant concessions can be granted. The loan documents and a lender’s unwillingness to enter into a modification may restrict the landlord’s ability to provide the tenant with the needed relief.
If the economy doesn’t bounce back as the public health restrictions are lifted across the country, substantial reductions in rental income could inhibit the ability of landlords to pay property expenses and loan payments to real estate lenders and may ultimately result in landlords also violating financial covenants in loan documents.
Economic downturn could provide tenants with more bargaining power than they may otherwise expect
The down market and impending recession due to the pandemic may provide all tenants more leverage in lease discussions with landlords. Tenants are not going to be easily replaced in the current climate if workout negotiations fail with existing tenants and they opt to repossess leased spaces.
Access to the courts could determine how long it will take landlords to move through the eviction process, a process that will be significantly longer as a result of COVID-19 for landlords in many parts of the country. As a result, landlords may be more flexible and willing to negotiate a lease modification and slower to vigorously pursue rights under the lease.
The full impact of the COVID-19 pandemic on commercial real estate won’t be known for some time. Commercial lease negotiations between landlords and tenants will undoubtedly take into account the unprecedented situation for years to come.
About the author
Amy Mistler is the office managing partner for Spencer Fane LLP in St. Louis. She is a commercial real estate attorney representing developers, investors, lenders and borrowers in all types of real estate transactions, including the acquisition, development, sale, exchange, financing and leasing of office, retail, multifamily and industrial properties.