Lease Renegotiation Starts with Finding Common Ground

The COVID-19 pandemic has strained many commercial real estate leases. Landlords across sectors are facing difficult questions. Is forbearance a way to keep tenants in properties? Are rent deferrals a short-term solution to disruptions in retail, multifamily, hospitality, and other sectors?

Pinterest, the image-sharing social media service that allows users to categorize their posts, offers an example of how quickly things can change. In March 2020, the online giant signed a deal for 490,000 square feet of office space in San Francisco, totaling $440 million in payments. By August 2020, Pinterest decided to pay the landlord $89.5 million to cancel the contract.

To prepare for lease negotiations, picture the four parties in a typical lease—landlords, property managers, tenants, and lenders—as legs of a stool, relying on one another to remain operational. A successful renegotiation means these players need to work together to preserve an asset’s income and value.

1. Landlords want strong revenue, offset by cost recovery and other tax advantages, to generate annual income and positive before- and after-tax yields (internal rate of return). During a disruption, however, both the return and future value of the property can be jeopardized.
2. Property managers look to achieve the highest annual income (net operating income) for the landlord and control expenses, all while handling the day-today operations of the property and keeping the tenants satisfied.
3. Tenants care about property maintenance. Even though they may be in distress and require assistance during a disruption, they are still concerned with the operation and viability of the property.
4. Lenders are not all alike. They can either assist a property owner during difficult times or hinder the process because of inflexibility. Lenders vary in their willingness to renegotiate with local or national banks and private institutions.

In any renegotiation, tenants and landlords want to preserve income and continue to be able to pay all obligations. Tenants, though, hope to maintain business income and keep control of the location, while landlords are interested in preserving the value of the building and maintaining ownership.

The most effective CRE professionals recognize opportunities to assist with lease modifications—and understanding the perspectives of everyone involved is a key first step.

This article was adapted from the CCIM Institute’s course “Lease Modification Strategies and Solutions.”