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Common Concepts in Lease Modifications

Common Concepts in Lease Modifications

Many commercial tenants are asking for and receiving lease modifications from landlords.  This blog entry focuses on lease modification concepts that I have seen in today’s commercial leasing market.  The concepts below are often used in various combinations.

To illustrate the concepts defined below, consider the following example: A retail tenant entered into a five year lease in 2008.  The lease commenced in June 2008 and expires in June 2013.  The rent is $5,000.00 per month with CAM charges of $400.00 per month (over a 2008 base year).  At the time of execution, the tenant pre-paid the last month’s rent ($5,000.00) and a security deposit equal to two months’ rent ($10,000.00).  The premises are 2,500 sf, which is about 500 sf more than the tenant needs.  The tenant’s retail business is struggling and sales tend to decrease during the summer season.

Temporary Rent Reduction – This is self-explanatory.  For example, the tenant could ask for a reduction of rent to $3,000 for the next 12 months.  This would save the tenant $24,000 over the next 12 months.

Permanent Rent Reduction – This also is self-explanatory.  For example, the tenant could ask for a reduction of rent to $4,000 for the remaining 36 months of the term.  This would save the tenant $36,000 over the remaining 36 months of the term.

Rent Abatement or Waiver / Suspension of Payments – The tenant could ask for a period of free rent.  For example, the tenant could ask for 3 months of free rent, and then normal rent payments resume.  This would save the tenant $15,000 over the next 3 months.

Forbearance / Deferral of Payments – The tenant could ask to defer rent for a time period.  For example, if the tenant has a large payment from a client due to arrive in 3 months, the tenant could ask for a rent deferral until the payment comes in.  The landlord likely will require information about that payment.  This option does not save the tenant any money, but it buys the tenant some time to keep operating and bring itself current.

Application of Pre-Paid Amounts Towards Rent – The tenant could ask for the pre-paid rent to apply towards the next month, and all or part of the security deposit to apply to subsequent months.  This option also does not save the tenant any money, but it allows the tenant’s money held by the landlord to be used now.  The landlord may require that the security deposit be reinstated later.

Percentage Rent Concept – The tenant could base its rent upon the success of the business.  For example, the tenant could ask to pay a portion of its sales for the next 12 months, and rent will depend on the success of the tenant’s business.  The landlord will require reporting and record keeping of sales.

Reduction of Space – The tenant could ask for a reduction of space.  If this is not a realistic option (i.e., the landlord cannot give 500-1000 sf to another neighboring tenant, or lease it to a new tenant), the landlord may be willing to charge rent on the space the tenant actually needs.  For example, if the tenant has 2,500 sf but only needs 2,000 sf, the landlord could agree to charge 20% less.  This effectively amounts to a rent reduction, but some landlords have found this reasoning persuasive, especially in office spaces where the company has laid off several employees.

Base Year Adjustment – The tenant could ask for a base year adjustment to the current year.  In other words, the 2008 base year would be moved to 2010, so the tenant would not pay any CAM adjustments until 2011.

Extension of Term – Many landlords will not agree to modify the lease unless the tenant agrees to extend the term.  This is often the case if the tenant is not struggling, but simply wants to take advantage of the current low lease rates.

Contingent Upon Tenant Performance – Every landlord should require that the rent reduction, waiver of rent, etc. is contingent upon the tenant’s performance of the remainder of the lease.  If the tenant defaults, then the benefit to tenant is void.  For example, if the landlord agrees to waive rent for 3 months, and then the tenant defaults after this free rent period, the landlord must have the ability to recover the rent from those 3 months.  Otherwise, the tenant simply received something for nothing and then defaults.

Early Termination Right by Landlord – I have seen a few landlords require an early termination right that allows the landlord to market the space to other tenants and terminate the lease if it finds another tenant.  For example, the landlord may agree to reduce the rent to $3,000 per month, but the landlord wants the right to market the space and find a new tenant that will enter into a long term lease for a higher amount.

Prior to using any language or concepts from this blog entry, consult with an attorney.

Ryan Rosensteel is a real estate and construction attorney licensed in Arizona.  You can contact him at rrosensteel@rrlawaz.com.

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