The Problem: Revenue Loss

Many co-ops or condos with commercial space are still grappling with the loss of revenue from retail tenants as a result of COVID. But as businesses continue to recover, it’s a good idea for boards to revisit any rent-reduction agreements to make sure they’re not getting shortchanged.

We worked with a co-op in a high-rent area on the Upper East Side that had a nail salon as a tenant. The salon had signed a 10-year lease in 2018 that required it to pay $40,000 each month with step-ups each May. After COVID hit in 2020, it was unable to pay any rent from May through July, but then the salon reopened and was able to pay $20,000 a month through the rest of the year. In January 2021, the board entered a lease modification, retroactive to March 2020, that reduced the rent to $28,000 through May 2021. Just about every co-op or condo that had commercial tenants had given their tenants similar reductions. The agreement called for the salon to pay $20,000 in cash and draw down $8,000 a month from its security deposit to make up the balance, which again was a common practice at the time. 

In June 2021, the lease reverted back to the original and went up an extra $2,000, to $42,000 a month, which the salon was actually able to pay. But in July, the tenant paid only $28,000. It was still struggling and requested an extension of the reduced rent. That’s when the co-op’s management company asked us to analyze the salon’s financials to determine how much it could actually afford to pay.

The first thing we reviewed was the profit-and-loss statement that was internally prepared by the tenant, which is a challenge because there were no audited financial statements to compare it to. Also, with businesses that generate cash sales, it’s unclear whether all sales are being reported. So we requested the salon’s bank statements for each month, along with W2s and 1099s. We reviewed operational ratios, payroll as a percentage of sales, bank charges as a percentage of sales, and other items. We did this in sections, from pre-COVID to the period after the salon reopened. We found that gross sales were about 75% of pre-COVID when it asked for the reduced-rent extension. The board did a second lease modification, resetting the rent at $30,000 through October 2022, then going up to $44,000 after that. Once again, the salon requested an extension. In my follow-up analysis, you could see that gross sales had really kicked up, so we entered a third modification, increasing the rent to $34,000, which will revert to $45,000 in November 2023. We’ll see what happens then, but I wouldn’t be surprised if the co-op reaches out again this fall.

Boards have to accept the fact that they’re probably not going to receive their pre-COVID rents. In this case, I don’t think the board is ever going to get the original rent they anticipated. What it is probably going to have to do is modify the lease going forward, maybe on a year-to-year basis. The attorneys for the board will negotiate with the attorney for the tenant and come to some sort of conclusion where they’ll meet halfway, just like any other contract negotiation. But you want to make sure that you get as much money as your tenant can afford.