I believe we can safely agree that we’ve entered uncharted territory. There may have been global pandemics in the past, but never in a globally interconnected economy. The Great Influenza, Typhoid, Yellow Fever, etc. devastated populations, but national economies were not crushed to the extent of those under the Covid-19 pandemic.
While our medical professionals are working tirelessly to manage the health issues of the pandemic, our business leaders are working to plot a course to survive an extended shutdown of undetermined length.
For most businesses, survival will be determined by one key factor: CASH. Managing cash flow is always critical for a business. Now that every company’s income has been drastically reduced, managing cash will mean life or death for every business. Of course, when revenues take a hit, the first reaction is to lower costs. Not surprisingly, controlling expenses has become the new focus of businesses. Typically, a company’s top operating expenses are payroll and real estate.
Some practical strategies for reducing your office lease liability:
- Rental Abatement – Full or partial free rent is usually the ideal relief for any tenant. However, most landlords are extremely reluctant to simply give tenants free rent in mid-lease term. Successfully negotiating free rent typically involves paying at least a commiserate number of months of term on the end of the lease. i.e. Extend the lease by 3 months in exchange for 3 months of abatement today. However, many landlords don’t see that as an even swap as the market typically offers a month free for every year to year and a half of term. Additionally, adding term possibly means more months at an above market rent at the end of your lease.
- Forbearance (repayment relief) – While most landlords aren’t keen to offer free rent, many may agree to forgiving late payment penalties. We do not recommend applying the adage of, “it’s better to ask for forgiveness than for permission.” Having your landlord on board is critical, given that successfully navigating forbearance, requires their agreement to not pursue late fees, eviction or other penalties.
- Smaller Footprint – Reducing the size of your office can be an efficient, long term strategy for reducing your company’s long term real estate liability. However, shrinking the size of your office is not always possible in the middle of a lease term.
- Delayed Payment of Operating Expenses and/or Real Estate Taxes – Think of this strategy as a way to receive a partial reduction in rent. Many jurisdictions and local utilities are willing to work with building owners in delaying real estate taxes and utility payments. Passing those savings on tenants provides a rental reduction while allowing building owners to continue to make debt payments. Landlords may also be willing to delay the payment of estimated operating expenses and real estate tax passthroughs until the end of the year.
- Resetting Rental Rate – Negotiating a lower rent today, in exchange for extending the lease term is a tried and true strategy for tenants with a high rental rate and a relatively small remaining lease term. This process involves negotiating a new market rental rate and amortizing the difference between current rent and current market rent into the new lease term. For example, under a lease with 3 years of remaining term, if the current rent is $60/SF and the market rent is $50/SF, the difference between current & market rents equal $10/SF per year, or $30/SF for the remaining lease term. If the lease is extended by 7 years (3 years of remaining term plus 7 years of new term), the new rent would equal $53/SF ($30 divided by 10, plus $50/SF).
- Applying Security Deposits – Landlords are becoming more open to applying tenants’ security deposits (without penalty) towards immediate rental obligations. This strategy is most viable when a security deposit held by the landlord was cash, as opposed to a irrevocable letter of credit.
The viability of making any of these strategies work depends upon a number of variables including:
- Landlord attitude
- Tenant wherewithal
- Remaining lease term
- Architectural efficiencies
Selecting and successfully executing the best strategy requires working with real estate professional experienced in leading these types of negotiations…preferably one whose experience includes helping clients weather a few previous downturns.
Government grants and SBA loans also provide an avenue to replace a portion of the income to help with overhead expenses.
Key provisions of the CARES Act:
- Up to $10M SBA loan thru an FDIC insured bank
- May be applied to payroll, health insurance and overhead expenses, including rent
- Loans through the CARES Act may be forgiven, however Only 25% of payroll costs may be applied towards other overhead (rent).
- The Small Business & Entrepreneurship Council have a good summary of the CARES Act at: https://sbecouncil.org/2020/03/30/whats-in-the-cares-act-for-small-businesses-the-self-employed-and-gig-workers/
The CARE program is intended to provide payroll assistance as a priority in order to make the loan forgivable. However, office lease costs can easily exceed 25% of payroll costs, especially in a high rent market such as Washington DC.