The Tenant and Landlord Tango: Reevaluate Your Relationship, It Might Just Save Your Business.

This article is designed to shed light on the inner workings of your business relative to that of the commercial real estate industry, whether you are an investor, landlord, business professional, or tenant in the new world we find ourselves in shaped by COVID-19. There are still many unknowns, but some things hold true. These concepts should help you to refocus your energy because you need it to survive the next year or two. Those that do will forever gain, and those that don’t won’t be around to reap the rewards. It all comes down to your relationship with each other and how you effectively manage them.

In fact, we can all achieve these goals in unison to draw from all of our collective gain, so everybody wins. At all levels real estate, the more we work together to set a standard of operation and image, the better it is for everyone as it is our duty to maintain credibility as it is the cornerstone to wealth generation and profitability. I do not think you have to eat someone else’s lunch in order to eat yours. There is enough to go around, but you want to make sure you have a seat at the table and staying well informed is the key to your success. Having lots of energy, positivity and a willingness to pivot, change, reconcile, help others and remain focused is what will pull you out of this pandemic in a good position.

I discuss many things in the article, but it can all be brought back to your relationships you form. They play a part in defining who we are, how we operate, setting expectations, and managing them in relation to those around us who create the supply chain we all need to all be successful at all levels of real estate.  

Wealth: One of the lost 5 W’s

Starting with the basics, Landlords need Tenants to pay rent, and Tenants need Landlords to provide space in an area that is geared to driving business into their doors. It is a mutually beneficial relationship. I was a commercial Landlord for over a decade and I’m third generation in the industry, I know how the business works intimately. Commercial Real Estate (CRE) is a complex network of almost every societal need and want birthed into a physical marketplace for everyone to take part in. When societal needs change swinging markets in a new direction, CRE is the first react as these marketplaces are somewhat sentient in that they manifest current human ideals, wants, and needs much in the same way Adam Smith stated so many years ago explaining how the invisible hand works.

The business model is simple from 30,000 feet. As a Landlord you prospect new lands and building developments or purchase an existing one for a market price. That price reflects how much rent they need to charge in order to operate, and the market will dictate what kind of tenants can afford to rent there. The more desirable the land, the higher the rents that support a different class of tenants and vice versa. 

There are so many barriers to entry into CRE, and a lot of risk is involved. One is obtaining large amounts of capital to purchase or develop land or buildings. This directly feeds the stereotype of exclusivity in the industry, but it can’t rely solely on capital to make it work. It also needs to rely on people to deploy that capital in smart and efficient ways. CRE industry related knowledge that is not common, taught in schools, or generally known even by the most astute individuals drives the wealth generation in CRE, or human capital if you wish to define it as such. You need both to be successful. When the economy and interest rates are good, things are very good, and Landlords can generate massive amounts of wealth when tenants are making enough money to pay good rents. When they are not, the commercial real estate industry and all businesses who pay rent suffer hard, much like what we are seeing now in pandemic times and onward after the fallout.

The key word that I keep using is wealth. Wealth is not money, it’s a combination of equity, cash and the human capital to efficiently conduct business. Most CRE landlords have very little cash on hand. Most of their money comes from operating loans backed upon the equity in their buildings. Leases back the income and validate the equity with lenders. When you sign a Lease, the landlord will most likely take that to the bank and borrow money to lend to you for leasehold improvements in your premises, or capital improvements to the building in which you occupy. If that Lease, or many leases go into default and cash dries up for the landlord, they lose wealth. You need your Landlord to have wealth, as cash is almost nonexistent unless they borrow against their investment to operate.

However, things have changed drastically over the last few weeks with the introduction of COVID-19 and the effect it is having on our economy right now. I use this as an example, because war, famine, or any other overbearing market force can and will hurt our economy as they all have the same effect.

It’s best to pay a market rent, and not try and get the lowest rate possible. Helping your landlord generate wealth helps you generate wealth in your business. If your business has lots of wealth, you could also borrow against it to expand, or improve your already existing business much the same as a landlord operating their business. In times like these, when potential closures of businesses might be common place, rent deferrals or forgiveness makes it very hard for Landlords to pay their mortgages and expenses as they can’t back their loan values and borrow money to help you out. This has a direct effect on their wealth they draw upon to expand or make concessions with tenants. Keep this in mind if you think you are going to help yourself, without knowing how you might hurt yourself by not looking for common ground with your landlord. 

Knowing these fundamentals is crucial in developing a good working relationship with your landlord. It is also important to know these fundamental business principles to help guide you through your journey. Wealth begets wealth, so put yourself on the right path. 

What About Market Rents? It’s all about equilibrium.

This obviously begs the question on what market rents should be, and what factors drive their valuations. We all know that rents just go up, but do they actually? In a normal well working economy, they often do. In speculation, there may be a new normal in market rents coming. How drastic of a change will it be? It may all depend on what businesses can afford, or landlords may be in trouble financing their properties and tenants won’t have the crucial physical marketplace they need to operate.

So, what changes with COVID-19? Well, the value of real estate might, and it will bring a lot of implications with it. There are many factors that make up real estate value and it is complicated. The major valuation tool in commercial real estate is income generation. If a landlord produces great net profits from rents, the property is worth more through a market capitalization factor. If they have desirable tenants paying good rents, the better the net profits and the more value generated in their venture. But what happens if these tenants can no longer afford these high rents at these expensive buildings?

Many businesses are shut down during this quarantine and hurting bottom lines and cash flows all in the name of social protocol or government intervention. Every choice comes with some good and bad, and it’s a delicate balance. You don’t want to close but you are unsure if your business can weather this storm, and it might not even be your choice! If tenants are so disrupted by the pandemic mitigation efforts they must close and move out and the landlord can’t replace them at high rents, the value of the property will start to slide, tenant default by default.

They must find a market equilibrium, in this case a market rent that works for the Landlord and tenant as they need each other to run their business. Obviously, this would mean lowering the average market rent to retain tenants and some profitability. This would lower the value of the building and depending on how much of the landlord’s mortgage is outstanding; be over leveraged in a high interest / deflationary time. There must be some reconciliatory efforts on both party’s behalf. The damage of businesses bottom lines and cash flow because of not being open to the public in this unprecedented time can’t all be put on the tenant or landlord exclusively. Good negotiations will help both parties get the best outcome, and its best to start with the knowledge needed to start them off right.

What can we expect as a new normal, and what role with Force Majeure clauses in your lease play in sorting it all out? That is up in the air, but we can try and start to prepare ourselves for what that may look like. In times of impending recessions, it may depend on what the government does to mitigate current issues, the mood of the business climate and culture, interest rates, but most importantly the unemployment rate and the free moving of people in society. Being proactive and looking out for your business now by securing your leased space at a tolerable rent for the longest period possible is in your best interest but only if you know what market rents will be into the future and the full effect of the pandemic is yet to be seen. This also helps the landlord retain a critical mass and some profitability, allowing the landlord to draw upon their equity to have cash reserves to run their building, giving you a space to operate your business.

The contract that governs the relationship between landlord and tenant are sacred. Many tenants are having a hard time paying rent, and landlords are having the same troubles collecting. Both and are looking for solutions. There seems to be some movement between landlords and tenants to find a solution for both as it’s mutually beneficial for each party. We are seeing these concessions in the news and the experiences I’m having everyday as a lease consultant show a new relationship of necessity forming between the parties. On the surface it seems easy to see the market equilibrium, but in practice there are so many variables it can be hard to come to agreement on how to tackle affordability and profitability.

Ultimately, the lease is to govern this relationship, but the standards and balance of power between landlords and tenants are changing much like many other things we are experiencing with today's markets. As the relationship changes, should the lease that documents it change too?

What about the Lease?

Working as a leasing consultant during the pandemic has been anything but status quo. The very essence of the commercial lease is changing. What do they even mean if both parties cannot live up to the covenants contained in them? It may signal the lease in theory no longer holds any weight as they are supposed to document a meeting of mutual needs through a physical document. However, there are lots of remedies for both parties.

Leases may seem stringent and non-negotiable, but they are “living” documents. I use the word living because they reflect how the relationship with your landlord works given the business environment you operate in. COVID-19 is disrupting that environment and your lease should reflect that. I was a commercial Landlord for long enough to know what they need to be profitable and stay open. They need tenants, that is their business, renting space.

You can change your lease through successful negotiations and mutually beneficial concessions. If you can’t afford to pay your rent because of reduced income which I believe will be commonplace in the coming months, Landlords will lose their ability to pay expenses like the mortgage. They need tenants paying rent, much the same as tenants need the landlord to keep the building open for business. Both parties will have to help each other out in these times by creating a security for each other. Below are a couple of ways to make both parties come to agreement.

Lengthen the Lease:

Let’s assume you are currently in a lease and you want to reduce your rent so that you can afford to pay it. You offer the Landlord a chance to have a longer lease term, but at reduced rates. There is a silver lining for both. The landlord can leverage the lease for financing because of the length of the term being extended, and the tenant can now afford to pay the reduced rent in the new environment the pandemic has created. Without this agreement, the landlord can’t pay his costs, and you don’t have a business.

Payment Deferrals:

Most landlords hold the covenant in the lease that you are to pay each month’s rent at a certain time and are expected to pay on time without excuses, including a pandemic. This is the most fundamental part of a lease. Asking for a deferral on rent won’t come without some agreement on how it will be paid back. Is the landlord willing to set up a schedule for repayment? In order to be able to afford it, do you lengthen the lease to get the lowest monthly payment possible? Yes, you can do this, and landlords in this time must keep their cash coming in and will have to make concessions in working with widespread cash flow issues.

The ultimate question becomes whether consumer spending will rebound to the record highs they once were before the pandemic and the answer is, not likely for some time. If your revenue is down at your business, how are you going to afford to pay back rent combined with your regular rent when your business metrics no longer make sense. I foresee more business closures and insolvencies in the coming months after the restrictions are lifted than during the actual shutdown to fight the pandemic as cash reserves only last for so long. If consumers lose their confidence, exacerbated by a slow or retracting economy, they are less likely to make purchases that are deemed extracurricular as they shift their focus to basic needs and goods. The next natural step is to ask for rent forgiveness which will be hard fought for.

Rent Forgiveness/Abatement:

This can be handled in many ways but the two most common are reducing the rental rate as stated in the lease for a portion or remainder of your term, or flat out asking for forgiveness on outstanding payments to the landlord. The facts are going to be apparent to all tenants and landlords in the coming months, cash will be short, and adjustments will have to be made. Concessions on both sides will be needed for both parties to remain successful. I don’t think this will be the first option, nor should it be.

Rent forgiveness is a last-ditch effort on the landlord’s behalf to retain a critical mass of tenancies so it is not to be expected until the dire last moment for them. This should not be your first ask during negotiations. Make no mistake, there will be a lot of business shutting their doors for good and there is only so much bleeding landlords and economy can take until the market corrects itself.

Maybe it is too early to tell, but with daily announcements coming out at the federal and provincial level governments, it can be hard to determine how long social distancing and lock downs can be expected. Many tenants and landlords are coming to agreements to defer rent for a few months in hopes that COVID-19 winds down in that time frame, but there might be a problem with these timelines.

Granted, the information coming from both government levels changes rapidly and can be a bit much to keep up with, a seeming strategy to lessen the blow of each impending additional measure that needs to be taken to prevent the spread of the virus. They are reacting to medical professionals giving advice on measures that should be taken to stop the spread of the virus, all the while trying to balance our delicate economy. Unemployment is up, personal income is down, and with no clear date into the future when we might see some normality, we can be in for quite a ride.

If the economy slows down and consumer spending with it, many retailers might not be able to afford their old rent structure let alone making back payments along with it. This all could end up in a big cash loss for everyone, and landlords can’t expect their tenants to brunt the whole loss of business. In normal times the landlord and tenant entanglement can be stressful from time to time. It is especially important that landlords and tenants realize they are in business together, recognizing they are in a mutually beneficial relationship governed by a lease. This lease needs to be adapted to suit the environment we now operate in.

Rental abatements rarely happen unless they are triggered in your lease by an action taken by either party. The most common is maintenance. A tenant might take on a cost that is the landlord’s by lease and will reduce the rent by that cost. This agreement is usually documented in the lease and in practice is often done due to the ease of business. Essentially, it saves the landlord and tenant time and money if the tenant executes the task that is of the landlord’s responsibility. Tenants cannot assume some form of repair they see as the landlord’s responsibility and make a unilateral decision to abate their rent in lieu of fixing the repair out of pocket. An express agreement from the landlord to allow the tenant to preform the repair and take an abatement is needed, or the tenant can be on the hook for the cost, but more importantly the liabilities that come along with it, and quite possibly a default of the lease itself.

If these shutdowns continue for a longer time period than a few months, at some point the ability of tenants to pay rent or lack thereof will become a problem for both. If landlords want to keep a good tenant base, they will have to make further concessions, or they risk losing a critical mass of paying tenants that will leave them in peril. Deferrals may just turn into abatements as business’ try to ramp their services back up in a reluctant consumer economy without being able to achieve their normal volume of sales in pre-pandemic times. For both to have success, they will need to find middle ground.

I keep using the term “finding middle ground” because it is changing everyday, announcement by announcement. We may not know where middle ground is for some time and navigating it will be tough. Lease agreements made today may not be relevant tomorrow due to the dynamic environment we find ourselves in today.

Strong Negotiations:

You may only get one crack at these negotiations in preparing for your future after the pandemic, best to do it right. It is good to know what is in your lease, and what your options are going into talks that may save your business. Get a lease review done so you know what position you are starting negotiations from so you can plan on going where you need to be. In knowing what landlords are looking for and for landlords to understand the difficulties tenants are suffering, making them an offer that helps each party are integral to a good negotiation and a positive stable outcome.

Landlords especially need to be in tune with tenant needs by understanding the macro state of the economy as to plan a general discourse with all of their tenants. As a landlord you need to keep an eye on the general market and economy to help understand what factors your tenants are facing. Knowing your financial needs, making a business plan and proforma cash flows in these new times, and incorporating them into your business model or lease is how you are going to remain open and profitable so your tenants can continue to pay rent.

Businesses that are deemed essential or sell commodities will fair out well relative to those business that are not. Prudent owners who also had built up cash reserves and had good debt to service ratios as not to be over leveraged should also fair well. Weak or struggling businesses before COVID, even with government help will have an uphill battle and might need to reposition themselves by making a pivot in their business model. This can be attained by looking at your business metrics and key performance indicators (KPI’s). If you don’t know, you can’t plan.

Business Model Metrics: It is a must for Landlords and Tenants

In preparation for managing your business relationship between landlord and tenant, each must have a great sense of what their respective needs are. Like any relationship, managing your own performance intimately is integral to the performance of both.

The saying goes “what you don’t measure, you can’t manage” Having a business plan is status quo. Everyone needs one to plan and obtain their targets and goals. One vastly overlooked aspect of a business plan is metrics. Its not just a buzzword, but your business plan laid out financially, with a set of rules about what is acceptable and what is not.

Having a business plan works great when things are going as they should, much the same way you planned in your model. You can look back and see if you are on target to meet your goals, or if you need to make a pivot to achieve your goals. They serve many different purposes such as setting values, identity, marketing approach, customer generation, retention, process and execution as they are meant to provide a path to success.

However, metrics are used very little in aiding all the attributes and goals of your business plan. What are metrics? They are a set of rules or objectives that are used to measure your success or failure, usually based upon past performance and compared against your industries key performance indicators (KPI’s). Depending on what industry you are in your KPI’s change.

KPI’s are relative targets seen as a percentage of your gross revenue. For example, most business’ want to fall in the range of 5-10% for rent. If you are grossing $1,000,000 a year you want to be paying a maximum of $100,000 in rent using these metrics. The exercise in analyzing your business metrics allows you to be adaptable so you can change your business plan to meet your performance goals. There are ways of controlling your performance when your KPI’s don’t seem at align with your industries KPI’s.

KPI’s produce strong budgeting targets because it is relative to your revenue and business performance rather than an arbitrary number set out, giving you confidence in your decision making. In the case of site selection and your lease thereof, if you plan your KPI’s correctly professional fees pay for themselves with real savings and rewards.

For example, fixing your rental payments as a KPI can be tough. You are in a lease with set out rents into the future and there isn’t much you can do to adjust them. Increasing sales to bring your rent metric down to a comfortable level is usually within your control so most business’ start there. You set out to increase your marketing budget and therefor increasing you KPI in that category. The goal is that it lessens your rent metric through increased revenue, and if your strategy works, at a greater return than the increase in your cost metrics. The other route is to minimize your other KPI’s such a labour, marketing, and cost of good sold. These avenues can be rewarding if they work, and thus creating a positive change to your business plan.

The most solid route is to set your metrics before you make a big move like committing to a long-term lease, or in turn, planning your rent roll as a landlord. You need to be able to predict how much revenue you will be receiving in order to know what you should be paying or receiving for rent. If you are a new business owner looking to lease space or a landlord trying to set an acceptable rent, this can be difficult to predict. Knowing what you can afford at the outset can help you in your negotiation of a lease as you can set upper limits to what your business can handle. It can help you not get stuck on a space you desire where rental amounts are not going to work for you or, continue with a space that is financially suitable. It can predict what rental increases your business or tenants can handle throughout the lease term in tandem with your revenue long term so you can plan accordingly. It is possible you will need to revise your revenue generation to meet the rents of your desired space or revenue generation. Landlords will also need to revise their business model in tandem with the tenant’s ability to preform financially.

Setting your rent well within your industry KPI over your lease term gives you a predictability that you can handle the ups and downs of the markets. Picking the right location for your business is important. Not all buildings have the same price tag. Often rent and marketing are reciprocal in that a good location and exposure can lessen your marketing metric but increases your rent metric. Knowing this concept with site selection is powerful in the planning department.

No one knows your business better than you do and this goes for both landlords and tenants. When you plan properly, a lease can become an asset to your business rather than a hindrance. For example, hiring a professional may increase your professional fees metric but can have a larger cost savings effect by lessening other harder to control KPI’s such as rent. How much rent you pay is important in that you don’t negatively impact your other KPI’s. The higher your rent KPI is, the more likely it will impact all your other KPI’s as a percentage of revenue in a negative way. This is true for operating costs a landlord pays for in running their building.

Keep planning and revising; stay up to date with the KPI’s of your industry. Consult with someone to make sure you are right and change your business plan accordingly if need be. It should be adaptable and not stagnant, and metrics allows you change accordingly in real time, with real numbers in your dynamic model. All these changes equal one of the hardest things a business can undertake, making a pivot. Including your relationship with your landlord or tenant into your business plan is essential to maximize your lease in setting goals for sustainable profitability. 

Make The Pivot: 

One thing I can put my money on is things won’t be “normal” when the time comes to reopen the economy after the pandemic. Businesses will have to approach cash flow, customers, employees, metrics, profitability, and most importantly their business model in a new way. Those that don’t might not survive.

You must start somewhere, but where to start? There are a few over riding things that can govern your business model and one is your lease. Its binds you to your existing location, demographics, and evolving consumer habits given technology directly in your trade area. For landlords, your leases set out your cashflows and thus your ability to be financed. These three areas will require a pivot on your existing business plan to achieve a balance in affordability and profitability. If these three areas are to change post pandemic, don’t let your lease drag you down with it. 

Landlords and tenants will be finding new ground to dance on together and the synchronized moves needed to make a beautiful performance won’t be lock and step at first. Each needs to be cognizant of who leads and when. Making the right steps forms a relationship between the parties on which each of their respective performance is greater than the sum of each alone.

Location: Is it still the right place for your business? If everything else in society is going to change, maybe your location should too.

Your lease ties you to a location that is of benefit to you. This is where your customers, employees, suppliers come to use your service, or service your business. The rent that you pay should be less than or equal to the benefit you get from being there whether it be income, customer traffic, high visibility, prestige, demographics or a natural exclusivity. You become part of the community and become a figure within it. When considering your business model and cash flow going into post pandemic territory, will you interact with your customers the same? Will you employees feel comfortable? Can you afford the trade off in location and consumption through proximity? Keep an eye on the market and real estate around you to paint a picture as it will start to tell you a story. This is a great way to start thinking about your pivot. Starting site selection now will keep you at the front lines to make a move when time is short and so is cash. Landlords may be desperate to fill a vacancy brought on by the post pandemic economy and you want to take full advantage of that. You wouldn’t want to start this pivot when the chance to change effectively has passed.

Landlords also might have to consider repurposing their building to that of tenants where their rent metric make sense. As a commercial landlord, the business model I followed was to buy buildings that needed many capital improvements through deferred maintenance in getting a lesser price on the project. You can’t change the location the building in on, but everything else can be fixed with money and human capital. I focused on healthcare and business offices in that we would buy shopping centres that were sickly because of neglect to areas such a proper tenant mix, outdated technology and overall lack of curb appeal. Overtime in attending to these issues you start to build a critical mass of desired tenants that create a destination using the theory of cumulative pull. Furthermore, we see large retail REITS who own large tracts of land used for shopping malls looking at the highest and best use of the land to promote the highest profitability in planning their pivot. As societal needs in consumerism are changing to an online world, physical stores are less frequented by customers. If that land was repurposed to high density residential/commercial mix as is being done in the greater GTA at an alarming pace, the natural trend towards better bottom lines presents itself as the only option.

Demographics: Will you customer base remain the same? If your demographics change you should know about it.

As you are at home you have extra time on your hands to think about your business market position. You should spend some time getting acquainted with your target area and the demographics within it a bit more closely. Who is your competition, who are your customers, and how that is it likely to change over time? You can devise a strategic game plan to prepare for the eventual change we are about to see in demographics due the economy shifts the pandemic will bring. People in a post pandemic world may move from the area in search of cheaper housing, become insolvent, have less household income to spend, or have greater expenses relative to their income. This will change they way they consume. Keep up on the ever-changing demographics of your customer base in the area you operate your business. You might be able to use this data to pivot your services or products to best meet and suit the needs of your customer, clients, and employees. Demographics are hard to do right in that you need to compare more than one data set to gain a clear picture of where your business stands. Planning without data is not planning at all, its guess work. Plan, plan, plan. 

Technology: Reaching your customer base will be different, be prepared to utilize technology to manage your expenses. 

The amount of rentable space you have may have to change because of consumer spending and productivity if you want to stay profitable and in business. This may also affect the size of land and building developments that investors may make due to demand. This is especially true for retailers and service business that will need less space in the face of less people consuming on your premises. Digital chat and show rooms have already been changing consumer habit, but COVID-19 has accelerated this through necessity. What is interesting is that being confined at home has made the way we interact with each other different, and it seems there is a mutual consensus that some is good, and some is bad.

People are becoming more internet and technology savvy which puts a world of products and services at their fingertips from the comfort of their own home. If digital meetings and appointments allows workers to stay at home, do you need a board room, or the costs of construction for a large occupancy to house all those employees? Those that didn’t partake in the digital economy are now having to by jumping in the deep end. Those that have embraced the digital world pre-pandemic might be at the finish line before you make it. Being proactive about technology might save you money on physical space in several ways, and your lease might be able to reflect that. 

It has already shown that landlords who utilize technology gain a competitive advantage over those that don’t. A modern building with all the new age amenities generally does very well as it allows the tenant to have an image of sophistication. You can retrofit buildings as well, and most of my time spent as a landlord was implementing certain technologies to gain this advantage. They could be as simple as card reader door keys to skylights. In keeping with building a good relationship between landlords and tenants, what benefits one side should also benefit another. 

What’s Next:

Earlier in the article I touched on what generates wealth, and its strategic planning and human capital that turns land and ideas into realities. What we need to focus on is wealth generation while cash is in short supply. Without it there is no cash to draw upon. Reorganize yourself to think about wealth and you will never have to worry about cash again.

Be proactive, don’t just wait for the fallout to consume you. Use the tools available to you. Do what you must do to remain successful. Sitting or your couch feeling sorry for yourself is a waste of your time and it won’t put you in the driver’s seat. I understand it can difficult but put yourself on a path of betterment when things don’t look like they are going to get better anytime soon and to be honest, things will get worse before they get better. Human ingenuity at all levels of real estate is what our industry has been built on, and that wont change. Regarding your relationship with either your landlord or tenant needs to be built on the premise of a mutually beneficial relationship guided by the principles that have made our real estate industry strong, resilient and profitable.

In dealing with COVID-19 and the fallout happening around us, be kind to others, remain professional. I took these oaths when receiving my Real Estate License, and you should never forget it as it’ s fundamental to wealth generation and retention. Whether you are a landlord or tenant, put yourself in their shoes and act accordingly. In the end we are all people and society can’t operate if we are only looking out for ourselves. Real estate requires many people and professions to operate seamlessly, be the driver of positive change and wealth. Manage your relationships, they may just be what saves your business.