By: Charles Castellon, Attorney at Law
Widerman Malek, Celebration, FL
The Covid-19 pandemic will continue to cause distress in commercial and residential real estate markets. The crisis has caused a sharp increase in tenant defaults, a growing national “rent strike” movement, business closures, and unemployment, among other sudden impacts.
Landlords are squeezed in the middle between defaulting tenants and their own mortgage lenders expecting payment along with other payees, including the property tax collector. As tenants struggle to pay the rent, landlords need solutions. This article offers an overview of the current problems and ideas for tenant workout plans. We’ll discuss solutions that may be applied in some form to both commercial and residential tenancies.
Apples and Oranges Commercial and residential leases are quite different. Commercial agreements are more complex, with many nuances including multiple categories of tenant payments, rent escalation, exclusivity of use clauses, and personal guarantees. These complexities provide greater opportunities for creative solutions through the sliding scales of lease terms, but workout plans may also be devised for simpler residential leases.
Where to Start Landlords should seek proactive and swift solutions. They can’t rely on the government at any level to solve these problems. The federal government and State of Florida have passed initiatives to stay evictions (and foreclosures) as emergency stopgap measures to keep families and businesses in their properties. Unless they are extended, evictions will return by June, with the underlying economic conditions nowhere near recovery. Eviction is a solution, but not the best one in every case. Litigation costs money and time, then the tenant must be replaced. All the while, the property fails to produce income. For these reasons, eviction-alternatives should be explored. Landlords shouldn’t repeat one of the major lender mistakes from the Great Recession. The banks refused to consider “loss mitigation” applications for relief such as loan modifications or short sales while borrowers remained current on their payments. From the lenders’ perspective, there was no problem while they were still getting paid. Loan servicers would tell borrowers, “call us when you fall behind.” This practice punished responsible borrowers desperately needing relief to avoid default. Proactive measures improve the odds of salvaging tenant relationships and containing the damage before it’s too late.
Potential Solutions Workout arrangements should be temporary and tailored to give tenants a fighting chance to stay and resume paying or make plans to move. The parties can be creative in using the following arrangements individually or in some combination.
Rent Forbearance Mortgage lenders have been offering forbearance plans to give borrowers breathing room. Forbearance involves suspending payment obligations for a fixed period, to be caught up later. Forbearance plans often defer the problem to set up the borrower for future failure, but a reasonable rent forbearance may work for landlords and tenants. The landlord may defer a portion of each month’s rent, or a series of payments until a later time. This type of plan can work well with commercial leases if the tenant gets relief funds such as the small business loan programs created through recent emergency legislation. Most tenants will be unable to pay all the deferred rent later in a lump sum, but could spread out repayment through smaller increments added to the base rent Many residential tenants only need time to gather themselves before resuming payments. Covid-19 has exposed many societal flaws, including the poorly kept secret that a large percentage of the population lives paycheck to paycheck with little or no cushion. Although there’s much debate over whether the economic reopening that’s underway will succeed in the long run, many tenants will soon go back to work and that will help landlords willing and able to wait.
Rent Reduction Landlords can reduce the rent for the remaining term of the lease or for some installments and then forgive it. Everything should be negotiable and sometimes the best damage control move is to write off some rent. A reduction may be considered in more dire circumstances where the landlord doesn’t expect the tenant to be able to make up deferred rent. With commercial leases, there should be flexibility to reduce the base rent, maintenance expenses, or other operating expenses. Because a commercial lease term is generally much longer than a residential agreement, a temporary reduction deal at an earlier stage gives the landlord a better opportunity to recoup losses during the life of the lease.
Rent Forgiveness Landlords may evict tenants who fail to bring delinquent accounts current, despite making new payments moving forward. Rather than evict, it may be in the landlord’s interest to simply forgive, or “abate,” the past-due rent or part of it. In many residential as well as commercial evictions, it’s difficult or impossible to collect money damages for unpaid rent. Many tenants are judgment proof, with no assets, or eligible for bankruptcy relief. It may be a sound business decision for landlords to cut their losses, accept the new rent coming in, write off the back rent, and let the tenant finish out the lease term.
Loan Conversion A creative eviction-avoidance solution is to convert rent receivables into a loan the tenant can repay. Ideally, the tenant would collateralize the loan with assets. In the commercial setting, there may have business assets upon which a lien could be placed or other real estate to mortgage. The existence of such assets to secure the loan makes this option more attractive to the landlord. A loan conversion would give the landlord some hope of recovering back rent instead of forgiving it. The lease itself may be amended so that default on the new promissory note constitutes a breach of the lease that would allow the landlord to pursue both eviction and collection actions.
Put on Your Sunday Best Many like to make landlords out to be the villains, as evidenced by the viral rent strike movement. The hard truth is they have a business to run, with stakeholders in their economic ecosystem depending on the rent. Tenant settlements during the pandemic won’t always happen and litigation may be necessary. Landlords will want to be viewed in the best light when they go to court. Landlords should strive to be as reasonable and compassionate with tenants as the difficult circumstances allow. It’s a good way to do business. Also, many judges will likely exercise discretion in favor of tenants out of sympathy for their plight when they believe landlords are abusive. Judges are human. Most evictions based on failure to pay (as opposed to non-monetary grounds) are black and white. There are, however, opportunities for judgment calls within the case, including the amount of time the judge gives a tenant before an eviction order takes effect. Landlords should try to work with their tenants before filing suit and make a paper trail of reasonable efforts to be the “good guy” to improve their chances for the best court results.
Do Something Now There will be many landlord-tenant disputes through the pandemic and resulting recession. Landlords would be very fortunate to emerge completely unscathed and should think in terms of damage control. They should proactively communicate with their tenants to seek win-win solutions as soon as problems arise. At Widerman Malek, we help commercial and residential landlords negotiate the best possible solutions and fight their court battles when necessary. Contact me to help you protect your real estate investments and survive the economic storm intact.
Charles P. Castellon began his legal career as a trial attorney in New York City in 1992. In 2003, he made a life and career change by returning to Florida, where he had lived previously and always maintained strong roots after attending high school and college. Charles is active in community, civic, and professional associations and has presented and served as a panelist on legal issues for organizations and associations throughout Florida as well as actively publishing articles and blog posts on his areas of expertise.