Richard Klein, Klein Greco & Associates
For co-ops and condos that have lost commercial tenants due to COVID, finding new ones is necessary to balance budgets. What kinds of lease requirements should buildings be thinking about?
Before I even get into that, I just want to say that it’s a great thing if you can find a new tenant. The biggest problem for co-ops and condos right now is that you have these tenants who are still there not paying rent and aren’t leaving. Buildings are starting to find new tenants, but a lot of my co-ops and condos are negotiating and hating where they're ending up. But they feel they have no choice. They'd rather get something than sit with an empty space.
Are we talking about just about the base rent and ignoring the other things that go into a commercial lease?
It depends on the building and what their situation is. In a larger building where there are 300 residential units and the maintenance cash flow is substantial, they might have more leverage with a tenant, especially if the retail space is divided up. In smaller buildings where there are six units and a retail tenant on the ground floor, that's a big part of their budget. And regardless of what the lease may say, do they want to fight about it? Do they want to litigate and pay legal fees trying to figure that out? It is a bottom line decision and boards want to try to cut their losses and do what's most feasible so that they can pay their bills. As we know, there's been a lot of assistance for both residential and commercial tenants, but very little for co-ops and condos. In the second round of paycheck protection loans, money became available to co-ops, but the paperwork was so exhausting that a lot of buildings chose not to bother with it. So there's very little relief.
Going forward, what are the lessons learned from the pandemic?
One of the things everyone wants now is a force majeure clause. That's when something happens — war, pestilence, things like that — that would prevent someone from doing something like paying rent or finishing construction. It wasn't really clear whether a pandemic falls under that language, but some retail tenants have brought cases to have insurance pay the rent based on that clause. And the courts have said no. So now we're seeing commercial tenants coming to us with very specific language about a pandemic similar to a COVID-19 situation. Some boards are adamant that they won't even entertain that, which I don't know if that's necessarily the right way to go. But there are other boards that say, "Okay, if there's a pandemic and you are shut down completely, then you'll pay X percentage of rent.” If you're a restaurant and you're doing takeout and delivery, then they pay maybe 50%. Boards are trying to come up with some formulas so if the situation arises again where we're in a lockdown, there’s a game plan to follow and there shouldn't be a lot of renegotiation.
What about the issue of whether you’re going to forgive the rent?
Most of my buildings said, "Okay, we'll work with you for now, but you have a 10-year lease, and once we get through COVID we're going to tack on what we forgave and you're going to pay that when things get better." A lot of tenants were looking to have it completely forgiven. Or boards will tie it into something like, “We’ll look at your gross receipts and you'll pay the base rent that was in the lease, but if you're doing really well then we want the opportunity to recover.” Some buildings will not do anything about the base rent, but maybe give a little leeway on real estate taxes or other additional expenses. There's been a lot of creativity and some of that's carrying on into new leases now.
What about personal guarantees?
There was a governor's order at the beginning of the pandemic that you could not enforce this for certain types of retail tenants, such as restaurants, gyms and hair salons. If one of those retail establishments is not paying the rent and then leaves, you can't go after the person who signed the personal guarantee. That hasn’t been litigated yet, so we don’t know where the courts will come down. But now we're looking to see what we can put into a personal guarantee to make sure that that doesn't happen again. Do we want to put in language that regardless of whatever executive orders might come down, you're on the hook? Or make it clear that it's only for the period of the pandemic, so that if you're in arrears before or after, the personal guarantee is still enforceable or once the pandemic's over? It doesn't seem fair for landlords to get left holding so much in arrears.
As for insurance, are there any kind of new requirements going into these leases regarding who's responsible for what?
We've always had the standard insurance provisions where the co-op as a landlord makes the tenant have liability insurance, property damage, business interruption insurance and things of that nature. I have seen cases where tenants have tried to collect on their insurance policies for business interruption rental income. And the courts have said the pandemic is not one of the things that is covered. If something physically happened to your place, if it was burned down for example, then you can get that coverage. I don't know if the insurance companies are going to make any changes to that, so I don't know that there's anything boards can get in the insurance provisions to protect themselves going forward. But as a landlord, I might require a bigger security deposit or a letter of credit so there's money they could draw down on, and add language where you have to replenish it not on day one, but over a period of time. And that in addition to rent, you want tenants to have to pay back the security deposit.
If you're a co-op or condo with empty commercial space that’s not in the most desirable area, can you market the terms of a new lease so it becomes more attractive than the building down the street?
There are some very savvy commercial realtors out there who will do that. And you want to put out some attractive terms there. I have a building in Midtown that’s not on an avenue, not on a corner and doesn’t have a lot of traffic, so there's a very limited amount of retail that would want to be there. We're working with a realtor who's trying to be very creative on the lease terms to attract a tenant that would fit well into the space.
It ultimately comes down to dollars and cents for the tenant. That can mean: How much free rent are you going to get for how long to fix up the space? What's going to be your real estate tax increase? I have some co-op buildings where we pretty much assign 50% of the escalation in real estate taxes to the retail tenant, even though they clearly do not have 50% of the space. Back in the day when we had leverage, they accepted that because they knew they were still going to make money. That might change a little bit now. There are a lot of ways to be creative to attract tenants, but it's always going to come down to whether they think they can make money or not.