How Struggling Businesses Can Renegotiate Rent

How Struggling Businesses Can Renegotiate Rent

by Nikodem Szumilo and Thomas Wiegelmann - May 05, 2020

Tens of millions of businesses around the world are currently struggling to cover their overheads, and most economic activity is being generated from people’s homes. This renders rent - for offices, entertainment/hospitality, non-food retail, and industrial spaces - a large but temporarily unnecessary cost item. The ability to manage it may be a key managerial skill for surviving the crisis. In this article, we cover the main points that every manager should consider before speaking to their landlord to try to reduce this expense and the main strategies that are likely to help both the landlord and the tenant. Finally, we note some likely consequences of these arrangements for future rental contracts.

Understand Your Landlord’s Position

The first step in a successful negotiations of rent payments is to understand the point of view of the landlord. While there are many different types of property investors who may own your business space, the most important features for negotiations are their cash position, attitude towards risk, and the ability to bear a rent reduction, as well as their contractual obligations.

For instance, real estate is a popular investment asset for pension funds because it traditionally provides a steady income useful in meeting their liabilities. If your buildings are owned by a company like this that relies on income, their priority might be to see some payments (even partial ones) being made. In contrast, many buildings are owned by investors who need to periodically report the value of their assets and income return (e.g. investment funds). Their priority is to report good performance, and they are more concerned with the overall level of payments than their timeliness. They may be less willing to offer a discount but more likely to accept a deferral. Also, these owners are in a difficult position because it is impossible to value properties at the moment, so they do not know how much their assets have lost in capital value. This puts them under pressure to manage income return the best they can.

Other owners have different priorities. Family offices who are focused on the long term may be most flexible in dealing with tenants to keep the in properties; in contrast, some property developers have much more of a short-term perspective. Knowing who owns your building and what their priorities are will help you prepare a good negotiation strategy.

Propose a Solution

If your business is in survival mode, you may not be able to pay your rent and should try to renegotiate the existing lease. We recommend that you approach your landlord with a proposed solution rather than simply stopping the payments. This gives you more options and reduces the risks you will face when the current crisis eases.

In preparing an offer for your landlord you may want to consider the below points:

Think long term: There are several parameters of your lease you can probably alter today that will not require any cash from you but will have value to your landlord. If you are a good tenant (in normal times), extending the lease for a longer term could be an attractive proposition to property owners who are worried about increasing vacancy rates in the coming years, especially if the recession proves to be a long one. A good example of this are hotels, which at the moment generate no income but have sustainable business models that rely on the properties they operate in. Extending the lease with a good hotel operator may be an opportunity for the landlord to secure a good tenant who will stay in place, avoiding the risk of an empty property during the recession.

It may also be possible to alter the covenants of the lease or remove some clauses that list the reasons the tenant can break the lease, which serves to reduce the risk to the landlord. Naturally, this limits the tenant’s flexibility in the future, but the present value of this flexibility to you is probably low if you are in survival mode. If you go out of business, it will cost you nothing. In fact, renegotiating your lease in this way does not affect your balance sheet, so it might be a good way to reduce your costs without affecting your credit or working capital.

Share the risk and the reward: Another incentive you can give your landlord is to offer them a different financial reward for allowing you to delay or waive your current rent payments. It can take the form of interest on the deferred rent or an income-sharing arrangement. A good example of the latter is to make the rent a percentage of the tenant’s revenue.  (In countries where “revenue” is known as “turnover,” this is called “turnover rent.”) This ensures that the tenant has enough cash to pay and that the payment is proportional to what they earn. Both differed rental payments with interest and turnover rents tie the payoff of the landlord directly to your future performance. Not only you will be able to defer any payments, but you can considerably increase the incentive your landlord has to help you stay in business.

This approach is commonly used in shopping centers where anchor tenants have a big influence on the value of the property. Turnover rents align the incentives of landlords and tenants and can be used in office and industrial properties, too.

Be entrepreneurial: Many established businesses are now in the position usually reserved for start-ups; they are cash poor but have the potential to generate income in the future. This means that they can use structures and ideas from the private-equity world to keep their business going. This includes paying creditors in equity, sharing ownership of assets, or perhaps even sharing intellectual property rights. In many cases this is an extreme version of turnover rent, where the tenant enters into a partnership with the landlord. This was relatively popular in the last financial crisis when many businesses that struggled with paying back their loans offered their banks equity instead of cash. These deals often turned out to be very lucrative for the banks.

Know what game you are playing: Some landlords are contractually obliged to enforce the lease agreements to the letter. If that is the case for your landlord, there is very little you can do to stop legal proceedings. However, because many courthouses are closed at the moment, enforcing legal rights and obligations may not be easy. This reduces the value of the “best alternative to negotiated agreement” (BATNA) for the landlords.

Your strategy should be reduce this value as much as possible to bring the landlord to the negotiating table. You should speak to your legal team about how to do this formally, and together you should look closely at the lease agreement when considering alternatives. Many chain brands - including such as Adidas in Germany, Burger King in the U.K. or Staples in the U.S. - have publicly announced that they will not pay rent. This created a very public debate about whether retailers or landlords should bear the pain of the shutdown - and it is likely a calculated strategy designed to force their landlords to negotiate.

Regardless of whether your landlord is able to work with you or not, talking to them will help if you are facing difficulties. Negotiations reduce information asymmetry. Even in a conflict, negotiations will help establish what risk you are facing and which lines the other party is not willing to cross. Information is critical to understanding and managing priorities and payoffs on both sides of the table. However, negations also help understand the motivation of the other party. For example, many landlords are worried that opportunistic tenants who do not need help will try to take advantage of the current situation and ask for rent reductions. Convincing your landlord that this is not the case for you is a good starting point for a discussion.

Nikodem Szumilo is an associate professor of economics and finance of the built environment at University College London.

Thomas Wiegelmann is a managing director of Schroder Real Estate Asset Management and a member of the Harvard Alumni Real Estate Board.