Break on rent can give tenants new lease on life
As the recession drags on, national retailers are mass mailing requests for rent reductions to their landlords. Does a small-business tenant stand a chance of getting the same relief?
It’s not easy, industry experts say.
“The landlord has no obligation to reduce the rent any more than he has the obligation to increase your rent because you are making too much money,” said Rafael Padilla, a principal at Par Commercial Brokerage in Santa Monica.
Even landlords open to the idea may not have the flexibility to make the cuts.
“A lot of tenants are forgetting that landlords are seeing their feet held to the fire” by lenders, said Wally Limburg, a partner in Strategic Retail Advisors, a commercial real estate brokerage in Newport Beach.
From a small-business owner’s perspective, rent concessions often appear to make perfect sense these days. Sales may be down sharply. Anchor tenants may have disappeared. Too many smaller storefronts are dark. Foot traffic is lighter. New leases are being signed at lower rates.
At Whisper Cafe on Ventura Boulevard in Encino, sales are down 30% to 40% compared with year-earlier levels as customers rein in spending on its signature French macaroons, omelets, lobster bisque and other Continental fare, said owner and chef Christopher Kermani.
Since last summer, the first-time business owner said, he has made only partial payments at times on the nearly $5,000-a-month lease for his 2-year-old restaurant and bakery, as well as the building’s common area.
Kermani blames his cash squeeze on the recession and an unexpected $10,000 bill last summer to replace his air conditioners. His landlord credited him $3,000 of the cost, he said, but after months of rent payments as low as $1,500, he was sued last month for $32,000 in back rent. Kermani filed for personal bankruptcy to halt the suit.
“It’s becoming more and more impossible to have a small business these days,” he said.
Tenants usually are on the hook for rent if they move out or shut down before their leases expire, unless they seek bankruptcy protection. Most landlords want to avoid such an outcome.
“I don’t want to lose a tenant, because once somebody goes out, it is difficult to get a new tenant these days,” said Tom Pashaie, a managing partner at Golden West Properties in West Hollywood and Kermani’s landlord.
His company, which has invested in neighborhood shopping centers in Southern California for 32 years, has given rent concession of 10% to 15% to troubled tenants recently, including Kermani, he said.
“I’m sorry to see it go this way, normally -- 99% of the time -- we save it, we work together,” Pashaie said.
Small tenants can take steps to improve their odds of winning rent concessions, including opening their books and offering something in return, experts said.
Tenants of all sizes are seeking rent relief in record numbers, industry veterans say. Requests picked up around January with rent adjustments in the range of 15% to 25%, depending on the sub-market, said Padilla, who works primarily in Santa Monica and Los Angeles.
The trend is expected to continue as the commercial real estate market struggles.
The retail vacancy rate for Los Angeles County hit 5.3%, a 10-year high, in the first three months of the year compared with the year-earlier quarter, according to Marcus & Millichap of Encino. The real estate brokerage projects that rate to grow to 6.8% by the end of the year, compared with 4.5% in 2008 and 2.8% in 2007. This year’s rate could hit 12% in the Inland Empire and 7.2% in Orange County, the report said.
Many small-business owners feel anxious about asking for a rent cut but think they have no choice.
“I don’t know how long we will be in the downturn,” said Renee Kim, owner of a Cookies by Design franchise in Long Beach. The landlord of her small neighborhood center gave her a 30% cut in her rent for the first half of the year.
“I felt like it gave me a lot of momentum,” Kim said.
For a mom-and-pop business, the best way to approach a landlord is through a letter explaining the situation in clear economic terms, said attorney Dan Villalpando, a retail development and commercial leasing partner at Cox, Castle & Nicholson in Los Angeles.
“That might go over better with a landlord than getting 30 letters from Starbucks for 30 centers they are working with asking for rent relief on all of them,” Villalpando said.
Be prepared to share financial information for the last three years. Include projections through the next year or two. Show how a rent concession would help your business survive. Have a plan for how you will improve sales so the landlord doesn’t worry you will come back in six months with another concession request.
Most landlords want their tenants to stay afloat, but they may face financial consequences if they lower rent. Many recent retail projects carry heavy debt loads, and those loans were underwritten by lenders on the basis of the full occupancy levels and high rents of recent years, said Caroline Dreyfus, a partner at Cox, Castle & Nicholson.
Some landlords can’t lower rents without the lenders’ permission. Others risk devaluing the property below levels required by the loan agreements. Many owe more than the property is worth.
Small tenants also need to keep in mind that just because their sales are down, that doesn’t necessarily mean they are paying too much rent.
Landlords track the occupancy costs, or the average share of costs that rent makes up, for different industry sectors.
“You might have a restaurant who’s done really well and sales may be off 25% but occupancy costs are still in range for that category,” Limburg said. In that case, a landlord might be less receptive to rent cuts.
Those that agree probably will want something in return. A 20% cut in rent for six months might be made up by extending the lease or raising the rent in the future.
Even if your request is granted, “it can open a Pandora’s box and unfortunately leave a lot of hard feelings,” Limburg warned. To minimize the potential damage, be prepared to prove a real need.
“To say, ‘I need rent relief because my neighbors have gone vacant and the market is different’ just doesn’t cut it,” Limburg said. “It really has to be shown to be an economic hardship.”
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