Covid-19 Silver Lining: Renegotiating Restaurant Lease Terms, part II

Covid-19 Silver Lining: Renegotiating Restaurant Lease Terms, part II

This post features an interview with my colleague, Howard Kline, a California licensed attorney and Nevada real estate agent with over four decades of experience representing businesses and commercial landlords and tenants.  I was introduced to Howard through his broadcasts on his show “CRE Radio & TV.” I didn’t know Howard until the COVID-19 restrictions were in place, but I found out about him within weeks of the shutdown. He was already broadcasting solutions for both landlords and retail clients to survive during the restrictions. And this was before we knew how long the restrictions would last.

I zeroed-in on Howard because he was so informative and was relaying complex issues very clearly. I’m honored that he agreed to meet with me to discuss lease solutions during Covid-19.

During the interview, we covered what is currently happening under the COVID restrictions for restaurant operations. We also discussed what Howard recommends clients to do in order to position themselves for success after the restrictions are lifted and for success moving into the next few years.

Ryn:  I’m hoping to discuss negotiating lease terms in the short term, so restaurants can survive these hardcore restrictions. And I’d also like to discuss lease terms in the longer term, so that restaurants can build back up to successful operation.

Howard: Over the short term, it’s a question of survivability for restaurants. Owners need to live to last another day. What we have employed in some of our negotiations when representing tenants is to try to get abatement if we can. But rarely does a landlord agree to abate rent. What is more likely the case is a landlord will agree to a rent deferral. And what we’re discovering and, frankly what I anticipated, is that COVID is not going to be all that short term. I spoke to a lot of people early on who said, “I don’t need a lawyer. I’ll just do this and get three months’ rent deferral.” If that was all lessees/tenants were going to do, they didn’t need me to help them. Unfortunately, a lot of other issues arose, and COVID is lasting much longer than we thought. As a result, the strategy is to stretch out whatever repayment schedule has been agreed upon as long as tenants can and as long as the landlord can afford to grant it.

What we need to understand is landlords have issues here too. For them, the best short-term solution is to grant a deferral to a tenant. One of the other alternatives that we’re beginning to see is moving into either percentage rent only or a hybrid of percentage rent. We are looking at anything that can help the tenant over the short term without doing too much financial damage to the landlord.

I’ve also seen, and I’m not a big fan of this, landlords extending the term of the lease. In some instances, the landlords want to do that. I’m not really sure why.

Ryn: I want to follow-up a bit on some of the short-term solutions you talked about. One of them is percentage rent for business owners who don’t have percentage leases. What that means is tenants pay rent based on a percentage of gross sales. So, tenants submit their financials to the landlord on a quarterly or annual basis.

Howard: …it could be monthly…

Ryn: Yes, it could be monthly. Tenants submit their financials to the landlord, and then they pay a set percentage, say 6, 7 or 8% of gross sales. Some people love that kind of lease; some people don’t. But this way, in terms of what’s happening with COVID, if sales are going down, then rent goes down. If your sales go up, your rent goes up. That said, percentage rent always has a minimum rent payment.

The other thing Howard mentioned was rent deferral.  I’ve been seeing landlords grant rent relief to my clients with a payback schedule that will begin at some future date. This will make their rent 1.5 or 2 times the normal monthly rent. And I don’t know many restaurant owners who could afford to pay double their monthly rent for 3, 4, or 6 months.

So, Howard, now talk a little bit about the long term.

Howard:  Most of what we see is that when the tenant goes to the landlord and asks to renegotiate their lease for rent relief, pretty much anything is open for negotiation at that point in time. And it’s not uncommon for the landlord to request other changes in the lease that they may not have otherwise had. Or they may have problems in their lease that COVID has exposed. So, there’s a lot more attention now paid to a force majeure clause. By that I mean unforeseeable circumstances that prevent someone from fulfilling a contract. You’ll hear more and more of that, most of which is potential depending upon the language of the lease.

With regards to new leases being negotiated now, we’re seeing a lot of short-term leases. So, a lot of landlords are thinking, “In two years or three years, COVID is not going to be an issue so we’re just going to give a rent reduction until the end of the term. By then, we’ll be able to get increased rents according to the market.” So, in this case, the market will cure. That was pretty typical of the many recessions that I’ve been in. Landlords just give a short-term lease in anticipation of some sort of extension upon which the lease terms will go to market rate.

Ryn: So, the landlords will draft amendments to the lease with regards to the terms of the options to change from some previously determined set price to market rate.

My friend Matt, who own’s Roma’s Ristorante Italiano in San Francisco, was offered percentage rent from a landlord with whom he’d recently negotiated a new long-term lease. I was shocked and pleased to hear that was the solution they’d come up. Matt is in a unique position in that his landlords have owned the real property for a very long time, and they know that Matt’s success is their success. So they really worked with him.

So, Howard, I know that every lease is different, and every lease situation is different. But from your vantage point, are there a general set of best practices or recommendations you might make to a restaurant owner who is negotiating with their landlord?

Howard: Absolutely. If you need rent relief, be proactive. Do not wait until you’re one month, two month, or three months behind. In March and April and May, there were rent moratoriums that were applicable. The Judicial Council prohibited the issuance of summons and unlawful detainer action until the end of the beginning of September [2020]. So, for the most part, that doesn’t apply anymore. I know in Sonoma County, it doesn’t. In San Francisco, and a couple of the other cities, they do have some moratoriums on commercial evictions. But generally speaking, the commercial tenants aren’t as well protected as the residential tenants. So, if you want and you need rent relief, as I said, be proactive. Get as much data and information to the landlord indicating that you need relief. The idea here is to make it as simple as possible so the landlord will say, “Yes.” It’s kind of what we do in court when I have to write something. I try to make it as simple as possible for the judge. If the judge has to refer to different places, it’s too much work. You increase the opportunity to lose.

Consider your landlord to be a partner, not an adversary. And this is an attitudinal change. Restaurant owners have to understand that the landlords are having a lot of grief themselves. And as I’ve said in many of my webinars, most people aren’t at fault having to do with this COVID thing. So, the best way for everybody to survive, including the landlords, is to spread out the pain to as many people as possible. That way no one tenant is feeling all of the pain.

And finally, it is important to be transparent. Now, when I say that, my tenant-clients are going to say, “Well, you don’t tell them everything, do you?” And the answer to that is for the important things, such as what you need to get in order to convince the landlord, it’s important to be transparent.

If your business is down 50%, give them the documentation. As someone who represents landlords, I’ve got letters from national tenants with multiple units saying, “We want you to abate the rent.” But I knew that they sent that same letter to 2000 landlords. And I wrote back to the General Council and said, “Eh, that’s not going to happen on my watch. You’ve got a couple of days to pay your rent.” And you know what they did? In their case, it was a philosophy of, “If we asked 2000 landlords to abate rent, maybe half of them will agree to it. Why not?”

Ryn: What is happening in Sonoma County right now is that the restaurants were just allowed to open-up patio seating. So, the really compelling narrative to write to the landlord is, it’s one thing to be open again, it’s another thing to be able to access your employees after weeks of being unemployed. Often restaurant owners find out the day before they’re allowed to be open again. So how do they set schedules?  Or buy and prep food? Today we have outside seating, but we’re also having torrential rain. So it’s not just COVID offering all these interruptions in being open, it’s the question of how does a restaurant owner stay open? And for restaurateurs, they can’t sit on that kind of inventory. If they’re prepping food and then they are forced to close, they lose that inventory.

So, Howard, can you take a minute to talk about the difference between terms like abatement, relief, and forbearance?

Howard: Yes. Relief basically encompasses forbearance and abatement. Abatement is basically forgiveness of rent. Deferral means you’re just kicking the can down the road, and eventually you’re going to have to pay it back. I will say this, with abatement, be careful because as a representative of a landlord I put in a clawback provision. And the clawback provision means that whatever we’ve forgiven, you’re going to have to pay it back if you default. So, if you just see the word abatement, it does generally mean that the rent is forgiven. But it may not be forgiven forever, and you have to be careful to read all the terms of the lease to see if the landlord has slipped that language in. I make it very clear, “Hey, here’s the deal. If it’s going to be forgiven and you default, you’re going to have to pay it back, alright?” But there are some attorneys and landlords who will kind of slip it in.

Ryn: I’m in the process of selling a restaurant for a client who is in arrears on his rent. And what’s going to happen is through the sale, he’s going to be able to pay back the rent. The landlord is saying, “I’m not going to look at your buyer and consider your buyer as a new tenant until you bring rent current.” So, it’s a no-win situation because my client won’t have the money until the sale closes escrow. Of course, the landlord can secure his payment by submitting a demand to escrow. Do you have a suggestion on the best course of action in a case like this?

Howard: I dealt with similar situations on many occasions where the landlord was just adamant. But fortunately, some clients hired me beforehand, so that we could strategize the best way to put the landlord in the worst position. And whether or not the landlord has to act reasonably depends upon the language of the lease and whether or not the lease gives the landlord absolute discretion. I mean, there are a lot of other factors. Because I almost always represent landlords, I’m in a pretty good position to figure out what their weak points are. And I get a lot of thrill out at seeing a situation where I can go, “Okay, I think if we do this, the landlord’s going to do that because they have a knee jerk reaction to act that way. That’s not going to be good for them because all of a sudden, it’s going to make it more expensive and more difficult for them to get anything.” But basically, my answer is…have your client review the lease with an attorney. Come up with a strategy that will show the landlord that going through with an acceptance of the buyer is in the best financial interest of the landlord.

Ryn: The argument is that the landlord is going to be in a worse position by denying the buyer and trying to force the seller to pay. That will basically kill the sale of the business and, ultimately, the landlord is going to end up with a space where the business has gone dark. He or she is going to have premises that aren’t leased, and right now it will be very difficult to lease. That argument is much better made by an attorney, a real estate agent, or by the tenant than it is by me because I have tried it many times. So, this is where it might be worth a little bit of money to bring in somebody like Howard to operate on your behalf. But I recommend that you don’t bring the attorney in first. Try to work things out with an attorney advising you in the background. But, for better or for worse, the case that certain lease negotiations are in the best interest of the landlord is typically more effective if it’s made by an attorney.

Howard: The attorney adds (especially someone like me that’s been around a long time and I’ve handled a lot of business sales transactions), the legal maneuvering in the background. The argument that the landlord would be worse off with a vacant space is a common-sense argument. But in that instance, it’s a partnership. I’m not talking about the landlord-tenant partnership, I’m talking about the broker-landlord partnership. Or rather the broker, attorney, and accountant. A broker, such as you, Ryn, is going to be familiar with what the market is for the sale of the businesses, and you will be able to make those arguments. In my case, I kind of take all of that, and I mix it up and maneuver it around until it’s a big snowball. But I really rely upon the other experts.

I’d like to add one more thing. A few hours ago, I did a webinar on landlord due diligence. I had some wonderful experts on, including Ken Lamy, who does stuff nationwide. He’s a forensic accountant. And he’s the one who the landlord gives all the tenants’ data and information and financials, and he chews it up, spits it out and says, “This is what the tenant needs. This is what the tenant can do.” Then the landlord can make decisions from that. I had the head of West Coast leasing for Federal Realty Investment Trust on. He gave a landlord’s perspective. I had Peter Morris as well, he has been on my show a number of times. Ryn, you in particular would be interested in this because it gives you that in-depth analysis and what is going through everybody’s head when all of this is going on.

If you’re interested in viewing Howard’s very informative show CRE Radio and TV, head over to https://www.creradio.com. There are a variety of very helpful articles, podcasts and videos that explore issues concerning the commercial real estate industry.

Visit Ryn’s Facebook Page to stay hyper-current on her topics of discussion. You can also subscribe to Ryn’s YouTube Channel, where her entire series library is featured.

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Ryn Longmaid is a restaurant broker and consultant at Santa Rosa Business & Commercial in the San Francisco NorthBay and the host and founder of the Facebook Live Series, Deep Dish: discussions on the business of restaurants for restaurateurs, restaurant buyers and sellers and the restaurant curious.

As well as being a licensed real estate broker, Ryn is a CBB with the California Association of Business Brokers (CABB), a CBI with the IBBA and she holds an MBA in Sustainable Business Management. In addition to being a proficient business broker, Ryn has over 20 years’ experience in the restaurant, hospitality, and food industries. She has served as the executive chef for Amy’s Kitchen, personal chef to actor Don Johnson, she founded and operated a successful and longstanding restaurant. She has also held teaching posts in restaurant management at the Art Institute-San Francisco and The Culinary Institute of America-Greystone.

Howard F. Kline is a California licensed attorney and Nevada real estate agent with over 4 decades of experience representing businesses & commercial landlords & tenants. He’s handled business purchase & sale agreements, mergers and acquisitions and other businesses-related matters as general counsel, director of real estate and chief legal officer for 4 different corporations.

Although he has a broad range of legal experience, over the last 13 years, the major focus of his legal practice has been in the representation of commercial landlords and tenants, including: evictions, rent collections, lease negotiations and foreclosures.

Since 2010, he has also been the founder and host of CRE Radio & TV, a cutting edge online, news, talk and interview show on a variety of commercial real estate matters.