Recession Remedies

Here’s a conundrum: your commercial tenant falls behind in the rent. You send him a friendly reminder notice. Then a not-so-friendly reminder notice. Then a friendly letter warning of dire consequences. Then a not-so-friendly notice letter again warning of dire consequences – and finally, if he still hasn’t paid…do you go ahead with the dire consequences? Do you kick him out?

That’s the dilemma facing a 220-unit co-op in the Murray Hill section of Manhattan. A new tenant has fallen several months behind in rent. Complicating matters: the newcomer took over the lease from a previous tenant, who had also fallen into arrears. Sam Milgrim, the board’s treasurer, says the building has a “wonderful” relationship with five of its six commercial tenants but admits that things are getting thorny with the one in arrears.

“Either the tenant is going to have to pay us what he owes us or come to us with a plan, or we are going to need to vacate and put someone else in there. We are trying to decide at this point whether we are going to encourage them to stay.”

Should the building’s budget take a monthly hit from the failure of the one tenant to pay rent? Milgrim says the board is still “reviewing our options.”

While the board is deciding, the stress level is rising among tenants who are paying on time and also among shareholders who worry about the budget. But Milgrim indicates they may hang tough: “We’re not going to give anybody a free ride,” he notes. Still, the streets of Manhattan are littered with the results of such threats: real estate attorney James Samson, a partner with Samson Fink & Dubow, has counted 19 vacant storefronts between 57th and 86th Streets “just on the east side of Madison.” And that underlines the dilemma faced by situations like the one facing Milgrim’s co-op: when a commercial tenant can’t pay the rent what’s a board to do – reduce it, or kick ’em to the curb?

Finding a good commercial tenant can be a tricky proposal even in the best of times: you have to register with a broker, review prospective tenants, perhaps offer to void the rent while the tenant renovates, and then pay a broker’s fee that can run upwards of 30 percent of the first year’s rent. In an up market, a commercial space can sit vacant anywhere from a month to a year while the broker, landlord, and tenant negotiate the lease. And in a down market? Don’t ask.

These days, says Samson, he’s fielding more and more calls from nervous co-op and condo board members who can’t afford to lose their commercial tenants but are upset because rent payments have started to slide – or the tenant has come to the board, hat in hand, asking for a rent reduction. With everyone feeling the pinch in the recession, what’s the wisest course to follow?

Look at their history. If it’s a long-term tenant with a history of paying on time, it may be worth it to consider a rent reduction. “If the tenant is marginally not making money, you can lower his rent to an acceptable level so the tenant can survive,” Samson notes. “What you don’t want to do is lower his rent and then have him default.” Even worse, you don’t want a tenant to come in and complain that he can’t make it and then use the rent reduction to earn a bigger profit.

When it comes to deciding whether to negotiate with current tenants, or finding a new tenant, management executive Ellen Kornfeld is a big believer in “a bird in hand theory.” With fewer and fewer tenants able to pay market rates, “the most important thing now is to try and work with your tenant and try to keep them there, making some concession or holding back on [rent] escalations,” advises Kornfeld, who works with the Lovett Company. “Right now, it’s more important to have the tenant than to have a vacant store. It’s dangerous when you have a vacant store: you have vandalism, bugs, and it takes away from the look of a building.”

Consider rent forgiveness or rent deferral. If the board is willing to negotiate a rent reduction, then some key particulars need to be worked out. Will it be a rent forgiveness program or a rent deferral program? And how long will the reduction last? Will it be for six months? A year? Two years? For the balance of the lease? “These are all interesting questions that the board needs to think about before it’s too late,” warns Samson.

Many leases also have a guarantee that the tenant will pay rent for the remainder of the lease – even if he is no longer in physical possession of the property. This can lead to time-consuming, costly litigation as you try to get money from a tenant who has vacated the premises before his lease is up. You may want to renegotiate the lease so that the tenant is only obligated to pay the rent while he is in possession.

Move quickly and check the assets. If a tenant does start to fall behind in arrears, or suddenly stops paying rent, the board needs to move quickly and find out whether the company has any assets. “It’s imperative you try to make sure there is something in your records or files – if there are any bank accounts that are in the area that you can put a judgment against. That is key,” stresses Kornfeld. “I have tenants who are foreigners – they keep a minimum amount in a bank account here, so you can never collect” when and if there is an issue of arrears, notes Kornfeld.

Think about investors. One possible solution is for boards to consider selling their leases to an investor, who would then own the space and pay the monthly rent. The upside: the income for the building would be as secure as your investor. The downside: by selling the spaces, the board loses the right to say no to unwanted renters. “Some buildings don’t want to give up the retail leases because they want to dictate the terms of the lease,” says Kornfeld.

The biggest problem for boards right now is that many have never been through a down market. “It’s really been a landlord’s market for a long time,” observes Eric Anton, executive managing director of Eastern Consolidated, a real estate investment sales company, and the vice president of his co-op board. “Now you have a situation with a good tenant approaching the board saying he needs a reduction in rent. The co-op’s been a little bit spoiled. They haven’t had to deal with tenants going bust. So as a board you face the challenge: are they telling the truth, are they going to go bust, are you going to be left with a tenant who can’t pay or do you give them a break, and catch up later? I’d rather keep a tenant in the space, have some rent coming in than have a vacant space. It’s just not a good market now.”