Stress-Testing Your Rent Roll

Manuel Fishman, Real Estate Lawyer at Buchalter Law Firm. Image courtesy of Buchalter Law Firm

The extension of many local and state emergency orders preventing office tenants from reoccupying their premises, and retail tenants from reopening their businesses—through mid-May, at the earliest—requires careful attention by asset managers and financial officers at real estate portfolio companies. 

Specifically, assessing which tenants have the financial strength to restart business operations and reach pre COVID-19 revenues, to enable catching up on deferred rent and staying current on rent obligations, as they become due.

Some tenants are growing concerned that the last two months may result in the termination of their business. For landlords, this requires making the difficult decision of cutting losses now—and avoiding being dragged into litigation and a bankruptcy—or banking on the long-term success of the tenant. Landlords are encouraged to do some serious stress-testing of their rent rolls and focus on how to address the rent deferrals—forced or voluntary—that have been extended to tenants. 

Tenants with single revenue sources or revenue sources that are highly dependent on travel, hospitality, tourism and consumer spending, may find that any recovery may come too late to ramp up operations quickly enough to sustain pre-pandemic revenue projections. Landlords need to consider whether to take a short-term “hit” and recapture space, versus being entangled in a tenant bankruptcy where the landlord’s claim for unpaid rent is competing with other unsecured creditors. There are several lease restructure strategies that should be considered, and lenders need to be consulted as to what loan document covenants may be impacted.

The litigation delays and legal theories that lawyers will dream up in the next few months will likely infect the most common types of proceedings that enable landlords to terminate tenancies and regain possession of premises, where the issue is whether equity excused the payment of rent during this public health emergency. Access to the courts will be an issue. Some landlords will elect—or be forced to—proceed along this path. 

Smart real estate companies have already developed a policy for how to segregate their tenants between those that received rent abatement in exchange for some extension of a lease term, those that received rent deferral in exchange for a payback of deferred rent over some period, and those too big to fail that kept paying rent. Oddly enough, in the retail sector, the businesses that were too big to fail is the group in need of rent concessions, because, unless they have a robust online presence, their brick-and-mortar stores have been ordered closed as non-essential businesses, and their revenue sources have dropped to nearly zero. Similarly, the shared-office-space sector has been hit hard and there is a real question of its continued viability, as social distancing becomes the new normal for office occupancies.

Those real estate companies and executives that focus more quickly on stabilizing the rent disruption that has occurred, by stress-testing their tenants, may be able to take advantage of other opportunities more quickly. Many leases negotiated prior to the emergency shutdown orders may no longer pencil out for landlords—high tenant-improvement costs or tenants high face rent and long-term uncertainty. Releasing fully built out spec space may be the best market advantage for landlords trying to capture tenants in the market during the third and fourth quarters of 2020.

Think long term and be focused short term.  

Manuel Fishman is a real estate lawyer and shareholder at the Buchalter Law Firm in San Francisco. He specializes in retail, industrial and office leasing. He is an active speaker and author on a variety of real estate topics.