October 31, 2016 | By John Cumbelich
I was a Boy Scout, and now my boys are Scouts. You have most likely heard their timeless motto, “Be Prepared”. It’s not just wise advice for a camping trip, but a life lesson that applies to everyone, everywhere. As uncertainty in the business world rises, Scouting’s lessons of preparedness come to mind.
With vacancy rates beginning to creep higher across all retail asset types, as rents flatten and demand softens, users, lenders and investors in our industry have become more tentative. The specter of the next recession looms in the minds of many, no one exactly knowing if or when. And while we try to maintain the “business as usual” philosophy, the marketplace is noticeably more cautious than it has been in years.
One thing is certain, that the market, like all markets, will move into recession eventually. While we can’t forecast the timing or size of the storm with certainty, we can be prepared.
You will recall that during the Great Recession, scores of national retail and dining brands seized upon the panic felt by owners, and pressed to have rents renegotiated mid- term. Having successfully restructured many leases during those dark days, these users will no doubt seek to pounce again when the economy falters next.
Having worked through many such negotiations with our clientele during the last recession, our firm developed a sort of How-To manual, that very effectively turns the table and reverses the leverage dynamics of a rent renegotiation discussion.
Following then are our Rules for Owners:
- When your Tenant seeks rent relief, have the Tenant document the decrease in sales from the same period a year ago. A 10% decrease in sales is no reason to reduce rent. If sales have dropped by more than 25%, a conversation about adjustments probably makes sense. Have the Tenant demonstrate that the decrease in sales has been sustained over a period of months – not a mere decrease in last month’s sales.
- In the event that the Tenant is demonstrably suffering the effects of the economy and you feel a rent adjustment is called for, propose short term adjustments. Recoveries can take place over six weeks, six months, or longer. We advise that any rent adjustment should be targeted over a short term (e.g. 90 days). This will allow both parties to closely monitor the Tenant’s sales over the next few months, and then re-evaluate whether or not to extend the relief.
- In the event that rent relief is extended to the Tenant, always secure a corresponding Percentage Rent mechanism to allow the Landlord to recover the reduced rent as soon as sales recover.
- Most importantly, get something in exchange for the rent relief. We advise clients to require Tenants to permanently give up their exclusive use clauses, co-tenancy agreements, no build areas and/or other controls over the properties they occupy in exchange for any rent relief. Another excellent concession to demand would be the cancelling of future options or requiring those options to revert to market rents instead of being capped at 10% or 12% of the previous term. Giving up something precious is a foolproof way to smoke out a phony plea for rent relief.
- A final step is to require that while rents are reduced, the Landlord has the right to recapture the space and terminate at any time. This is the true litmus test, and will often cause Tenant’s to withdraw their request for reduced rent.
Owners can seize upon the business opportunities that a recession creates just as effectively as users, if they follow the rules above.
It’s still true that a recession isn’t something that we typically look forward to. But just like a storm cloud that hits your camping trip, it’s nothing to worry about if preparations have been made in advance.
About John Cumbelich & Associates
John Cumbelich & Associates is a San Francisco Bay Area based firm that provides commercial real estate services to Fortune 500 retailers and select owners and developers of retail commercial properties. The firm's expertise is in developing store networks for retailers seeking to penetrate the Northern California marketplace and the representation of premier Power Center and Lifestyle developments.