What considerations do both landlords and tenants need to discuss in terms of rent payments during COVID-19?
When the coronavirus (COVID-19) pandemic first began in the United States, the real estate industry initially thought any disruption would be temporary - just two or three months to “flatten the curve”.
With mounting job losses, big name bankruptcies, and continued infections, the COVID-19 pandemic will have devastating effects on the global economy for the rest of the year and likely much longer. As many states start the reopening process, Massachusetts is taking a conservative approach. And even as Governor Charlie Baker begins the transition from the statewide shutdown to a gradual reopening process, Massachusetts companies will not quickly return to business as usual. Commercial landlords and tenants will be forced to make difficult decisions to adapt to the changing real estate and business landscapes. Since rental obligations are one of the biggest fixed costs for any business and the primary source of income for a property owner, landlords and tenants must start to seriously dialogue about modifying their leases to help each party improve the prospects of their respective businesses surviving the pandemic. This article will cover several considerations landlords and tenants should discuss on the topic of rental payments during the COVID-19 pandemic.
1. Modifying Rent Payments
Many tenants, especially in the retail and manufacturing space, have not been able to conduct normal business operations during the pandemic. With the flow of business income screeching to a halt, companies are simply unable to meet their rental obligations. Over the last two months, landlords and tenants have discussed modifying rent obligations under leases in the following ways:
- Rent Deferral - Deferral of rent payments for a short period (e.g. one to three months). A tenant could repay the deferred amount by spreading out smaller payments during the remainder of the term of the lease. Alternatively, the lease term could be extended for the same length as the rent deferment and the tenant could repay the deferred amount during the newly created extension period.
- Rent Abatement or Rent Reduction - Payment of reduced rent or a rent abatement for a short period. The reduced or abated rental amount could also be repaid by the tenant in the same manner as described for a rent deferment.
- Payment of Taxes and Operating Expenses Only - Payment of only a tenant’s proportionate share of the building’s operating expenses and assessed taxes for a short period. The payment of standard rent payments could be abated or reduced during this period.
- Percentage Rent - Converting the monthly payment of standard rent payments for a retail tenant into monthly payments which are a percentage of a retail tenant’s actual gross sales at the leased premises. However, this option is not practical for an office lease.
Even if a landlord is amenable to any of the above suggestions, tenants should be aware that a landlord may need to obtain the consent of its lender for any lease modification affecting the payment of rent.
2. Returning to Work - A Phased Process
As Massachusetts begins to reopen, some landlords may feel inclined to push tenants back into paying “full” rent. However, business will not immediately return to normal for several reasons. First, Governor Baker has made clear that the reopening process will be gradual and in several phases. There will likely be initial occupancy limits for retail and office premises alike. We can look to the limits imposed within other states to get a sense of what is in store for Massachusetts -- most mandated occupancy limits are in the 25% to 50% range depending on the type of business. Second, employees who have become comfortable working from home may not want to return to work. Some employees may still harbor health and safety concerns, including the risk of virus transmission associated with the use of public transportation. Employees may also feel less productive in an office environmental with occupancy limitations and contact limitations. It will likely be easier and more comfortable and productive to work from home until the threat of COVID-19 subsides. Finally, customers will not come back right away. Many consumers will share the same fears over health concerns and a potentially unappealing in-person consumer shopping experience. Shopping malls and retail establishments are not likely to see normal foot traffic for several months at the earliest. For these reasons, landlords and tenants should discuss phasing in a return to full rental obligations just as the Commonwealth phases in the reopening of the economy.
3. Thinking Ahead -- A Recurrence in the Fall?
Although Massachusetts and other states have made much progress to flatten the curve of new infections ahead of a predicted decrease in the infection rate during the summer months, most health professionals anticipate a second wave of infections in the fall and winter months. This was a lesson learned during the 1918 flu pandemic in which the second wave in the fall of 1918 proved to be more lethal than the initial wave. As such, landlords and tenants should consider negotiating a mechanism to deal with rental obligations in the event of another partial or full shutdown if there is a recurrence of the pandemic conditions.
The rent issues described in this article are by no means an exhaustive list of what landlords and tenants should discuss considering the COVID-19 pandemic. Regardless of the issue, early and continued communication between landlords and tenants is critical for the parties to navigate the ever-changing economic landscape. Open dialogue and cooperation will be the best path to negotiating a mutually beneficial solution to get through the pandemic and eventually return to business as usual.