Why office leasing ‘technical defaults’ are bad for business

COVID-19 has introduced businesses to yet another a workspace management puzzle that many executives do not know how to solve: What to do with all this empty space.  

#NEXTONLINE hosted a webinar featuring Robert Copito, Vice Chairman at CBRE, one of the world’s largest commercial real estate services and investment firms, as part of its Virtual Lunch with an Expert series.

Most office tenants do not have the word “pandemic” or a global pandemic clause written in their leases. Even so, executives need to read their leases very carefully before employees start to return, warned Copito.

Landlord concessions: What you need to know

Tenants pondering whether to ask for rent deferral, how to negotiate with the landlord, or wish to skip rent payments altogether and risk entering into “a technical default situation,” Copito said, need guidance. Knowing what clauses are on the lease is as important as

learning the very few tenant-landlord negotiation techniques that may help reach an agreement, if the tenant’s business “really, really needs it,” he explained.      

Tenants who cannot get rent deferral may try to structure a solution that works. For example, Copito said, the landlord may agree to defer rent for three months if the tenant adds three years to the term of the lease. Most landlords will request the tenant to bring financial statements that prove hardship, because “a lot of firms, they feel, are perfectly suited financially to get through this crisis,” he said, but try to take advantage of the situation, or refuse to pay, and end up into a technical default.

If possible, he recommends office tenants must try to avoid not paying rent, which normally comes with loss of key tenant rights. “If you’re in technical default, you could lose the right to renew. You could lose the right to expand automatically, just by being in that category.” In addition, Copito says, the company’s reputation will suffer, and even may take a hit from competitors who could try to create a competitive advantage, and at the same time demoralize employees who may fear they will lose their jobs.  

“Before you take that step of not paying, just be very, very careful,” he said, have all the financial documents ready for the landlord, and do not expect to receive much empathy while the firm still is profitable. “Be very thoughtful before you even take this first step, because it can have unintended consequences.”

How to approach your landlord

Here are a few effective ways to approach the landlord, according to Copito.

  • If the lease term is coming up in one to two years, the tenant has much more control on the situation, than if the remaining term on the lease is seven to 10 years and lease renewal negotiations are far into the future.
  • The tenant likely will get a positive response from the landlord if the business needs “some financial engineering” to survive. Because unless the landlord helps the tenant to defer, lower or not pay the rent, to ensure the firm does not go into bankruptcy, the landlord will not get paid. And again, technical default also will have a reputational impact.
  • As a rule, landlords are more inclined to help a business that happens to be the largest tenant and has the power to cause “disproportionate impact on the underlying economic structure of the building.” The landlord has to work with the tenant and the lender to avoid mortgage default.
  • Lastly, the tenant may have “a very, very good, or long term relationship, with a very understanding landlord,” that may have lasted for decades, so the landlord may step up to help, but that is the least probable case scenario.  

A successful negotiation, added Copito, also can benefit from a tenant’s willingness to look at the situation from a landlord’s perspective and to seek expert advice.

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