When Tenants Can't Pay

What do you do when a commercial real estate tenant is struggling and may default on their lease?

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A client recently turned to the Fulmer Group for guidance when their retail tenant requested rent relief because the business was struggling. I’ve faced this situation often over the course of my career as a developer, landlord, and broker.

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The first line of defense is a matter of being proactive. Commercial landlords should focus on making sure any lease is as airtight as possible and that there are sufficient financial guarantees from the tenant’s side. Ideally, landlords should include the right to review tenant financial documents to detect problems as they arise. Of course, many privately held companies push back on this, finding it overly intrusive. (That’s not an issue if the tenant is a publicly traded company; the information will be readily available.)

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A major challenge is that, by the time a landlord becomes aware of the tenant’s problem, it’s likely that a number of other detrimental factors are already in play. Tenants often stop doing preventative maintenance and hire inferior contractors to save money.

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This can result in premature deterioration of building systems, substandard repairs that will need to be redone, and even cause additional damage to the property. Tenants may fail to pay their contractors, which could result in a mechanic’s lien on the landlord’s property. That type of lien takes precedence over the landlord’s mortgage lender and could put the landlord in default.

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A Call to Action

When facing potential tenant default, it is important for the landlord to act promptly and decisively. We recommend the following steps:

·????? Review the lease and make sure it is as detailed as possible. Consult with legal counsel to carefully craft changes for any case in which rent relief is granted.

·????? Obtain a market survey to get a sense of the value of the space and how quickly a new tenant could be found if the existing tenant defaults.

·????? Require the tenant to provide regular financial updates on both the business and any guarantors.

·????? Do a new credit check on the tenant and any guarantors.

·????? Thoroughly inspect the tenant’s space and schedule regular inspections to make sure that no unremedied damage occurs and that there is no substandard work or repairs performed.

· Conduct a lien search on the property to ensure no contractor has filed a lien.

The wisest course of action will vary, depending on what a landlord learns from the steps above. Perhaps it is a temporary problem that will correct itself. Regrettably, more often than not, the situation is part of a downward spiral that is unlikely to be reversed.

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Once things start to go bad, they can quickly go beyond bad. I have firsthand experience with many of the potentially catastrophic situations, including tenant bankruptcies in a state different from where they are renting, onerous mechanics’ liens, restaurants not maintaining grease traps and sewer lines, and tenants moving out in the middle of the night and stealing property and fixtures.

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Sometimes, the best option is to have a tough conversation with the tenant and structure an orderly exit.

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Dealing with tenant default is never pleasant, but it is part of the business of being a landlord. If you’re facing a challenge like this, shoot the Fulmer Group an email or give us a call. We can help you understand your options and, if needed, assist you in executing a solution.

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Paul Fulmer is the principal of the Fulmer Group, a multifaceted commercial real estate consulting firm. As a real estate specialist and thought leader, he has spent more than three decades advising clients on a wide range of real estate issues, from site selection, strategy, and risk management, to lease-vs-purchase analyses. He has tackled development and expansion projects from restaurants to office, industrial, residential, and mixed-use buildings. He works with public and private companies, as well as family offices. Paul has served on a number of community development organizations and non-profit boards. He spends his free time indulging a passion for fine cooking, entertaining, and travel. His primary residence is in Lancaster, Pennsylvania, and he frequently spends time in New York and Miami. He is married and has two sons.