Every tenant picks up the newspapers and reads that landlords are underwater on many of their buildings as vacancy rates increase and rental rates decrease. Smart tenants will find out they cannot outsmart or finesse their landlords. Virtually any new lease or restructuring of an existing lease involves an agreement between the landlord, the tenant and the lender.
Almost all tenant leases are subject to the rights of a lender or ground lessor which existed prior to the lease being signed or later became a party to a subordination, nondisturbance and attornment agreement with the tenant. Therefore, any deal a tenant enters into to modify its existing lease obligations will almost certainly require a new or amended agreement and the consent of the existing lender to insure the new agreement will be enforceable if the landlord defaults on the loan.
In today's economic climate, no lender or landlord will agree to reducing a financially strong tenant's rent, unless the restructured agreement provides the landlord an economic advantage. There are cases when such economic benefits are possible, which can turn out to be a win-win for the tenant as well as the landlord. Here are several possible alternatives.
The Landlord Can Take Back Some Space
In today's market unless the landlord is the owner of an almost fully rented building with a constant demand for space by new or existing tenants, there is little possibility that a landlord would take back space. In a dream world, if the tenant is leasing space below-market rate and the landlord is confident he could lease that space at a higher rate--after factoring in the tenant improvement allowance, brokerage commissions, downtime, etc. (re-leasing costs)--the landlord could take back the space and may even pay the tenant to terminate the lease. Even if those circumstances did not exist, a landlord may be willing to take back space if the tenant agrees to pay an amount of money in excess of the loss the landlord would incur by taking the space back and leasing it at a down-market rate. Still, the landlord would be concerned a prospective tenant may have a lesser credit rating than the current tenant.
Cancel the Lease in Exchange for a Fixed Payment
Since the tenant is not in the real estate business, he may try to quantify its costs and losses (which also involve accounting and tax issues) and request his lease terminated by a certain day in exchange for a penalty fee. These agreements often include asking the landlord to accept the premises back as-is. This is an attractive deal for the tenant because the loss is quantified and the tenant is relieved of responsibility for the surrender condition, which usually means investing a substantial amount of money to restore the premises to its pre-lease condition. However, the current marketplace makes it difficult to achieve such deals. In any event, it is nearly impossible without first obtaining the lender's consent.
Extend the Lease for Rate Reductions
If a tenant is financially solid, it would be unrealistic to think a landlord would allow the tenant to reduce its rent simply because market conditions have deteriorated. Likewise, it would be unreasonable to expect a lender to agree to a rent reduction barring a "trading dollars" exception. With a trading dollar exception, the landlord--in consult with his lender--may consider allowing a creditworthy tenant a cost savings on its rent obligation for the duration of the current lease term, by either reducing the amount of space leased or by a reducing the rent. These agreements usually require the tenant to agree to extending the lease for a five to 10 year period at a rate equal to a projected market rate, which landlords always expect to be higher in the future, in addition to the trading dollars and interest on those trading dollars. It's important for tenants to understand that this practice will only save them money in the short run, but they will end up paying more money in the long run.
Subletting or Having Someone Take Over Excess Space
Finding a subtenant or assignee can be problematic in most any market. First, the tenant has to determine a realistic rental rate based on the current marketplace. In all probability, rents are down in most markets and rents for subleased spaces are usually 10 to 30 percent less than that on direct leases. The tenant needs to then factor in what his costs will be for commissions to both the sublandlord's and the subtenant's brokers, what tenant improvement allowances have to be granted and what free rent has to be given. The credit risk always seems to be higher as inevitably many subtenants have an economic standing that is usually less then that of most direct tenants.
Tenants with strong credit and financial standing should approach the concept of relief from a situation with realistic expectations, a great deal of caution and the understanding that the lender's approval will probably be needed.
Michael E. Meyer, Partner at law firm DLA Piper has developed a national reputation as one of the preeminent leasing attorneys in the United States, representing leading financial institutions, accounting firms and law firms in connection with major lease transactions.