By Michael Schiff, EVP, Branch Manager

Flash back to September of 2008 when the first massive wave of the recession hit and it felt like the sky was falling.  The Dow dropped 778 points in its biggest single-day point loss ever, and giant companies like Lehman Brothers, Merrill Lynch, Fannie Mae and Freddie Mac were collapsing before our very eyes.  During the weeks and months that followed, almost every landlord received the influx of calls from their tenants who were saying, “I am going to go out of business if you don’t give me a rent reduction”.  For a large majority of tenants, they were not bluffing.  After all, there was a period of time when just about everyone, even the wealthy, put a hold on all of their discretionary spending.  Some tenants could not even weather the storm long enough to make their next rent payment, while others had a little more staying power.  Landlords were faced with the tough decision whether they should give rent reductions to those tenants who seem to really need it, thereby greatly reducing their NOI, or running the risk of dealing with a huge spike in their vacancies.

Today our economy is in much better shape with most tenants reporting a huge uptick in sales, retailers are starting to expand again and companies are back to hiring.  And while the verdict is still out as to if we are out of the recession or not, many businesses continue to struggle and tenants continue to ask their landlords for rent reductions.  It is often hard to decipher if a tenant really needs the rent reduction or if they are asking because they don’t want to be the only tenant in the center who hasn’t asked for one.  I can’t tell you the number of times I have heard landlords tell stories about how a tenant asks for a rent reduction, but then after the landlord asks the tenant to submit sales reports and P&L reports covering the previous 24-month period, the tenant drops their appeal for a reduction and never brings it up again.

One of my favorite stories is the one that involved a tenant who I had leased space to 4 years ago in one of my listings.  A year ago the tenant actually showed up in person at the landlord’s office on the day rent was due.  He claimed that he did not have enough money to pay his rent and proceeded to throw the key to his store on the landlord’s desk.  When the landlord handed him a form to sign which stated that the tenant was willingly relinquishing legal possession of his space, the tenant responded, “Aren’t you going to at least offer me a rent reduction?”  After the landlord said no, the tenant pulled the rent check out of his pocket and handed it to the landlord, and then picked his keys back up off of the landlord’s desk and walked out.  That tenant has continued to make his full rent payments on time every month and has not made a peep since.  This was clearly a case of ‘It doesn’t hurt to ask’.

But what about the tenants who really are struggling and really can’t afford to pay their rent?  Does it make sense to give them a rent reduction, or is it better to just replace them with a healthy tenant.  Obviously there is a very long list of factors that goes into making that decision (such as how far above market is the tenant paying, and how much confidence do you have in their ability to turn their business around if they are given a little bit of breathing room, etc. etc.).  And of course there are other factors to consider such as will losing these tenants in addition to the other vacancies you already have make your center look like a ghost town.  There are many things to consider, but here are some specific things to think about.

Nearly 50% of the borrowers who received loan modifications through HAMP (Home Affordable Modification Program) defaulted even after their payments were lowered under the HAMP program.  For borrowers who are unemployed for example or have experienced a huge drop in their income, reducing their mortgage payments is not enough to help with their income to debt ratios.

And while these statistics regarding residential real estate may seem irrelevant to struggling commercial tenants, it helps make the point that often times reducing the tenant’s overhead is not the solution – revamping their business plan and finding a way to increase sales is what they really need in order to get back on-track.

One of my other landlord clients told one of their struggling tenants (a franchisee of a company which shall remain nameless) that he would consider giving a temporary rent reduction if the franchisor agreed to do their part by temporarily lowering the franchise fees which his tenant paid the franchisor every month.  When the franchisor refused, stating that they could not afford to lower their fees, my client responded, “I cannot afford to lower my rents”.  Perhaps it was the high franchisee fees that were drowning the tenant and not just the rent, therefore lowering the rent might not be enough in itself to fix the problem in this case.

We have no way of knowing what percentage of tenants would turn their business around if they were given temporary rent relief.  I can tell you however that in the 2.4 million SF of shopping centers that I represent, I can count on one hand the number of tenants who managed to pay their new modified rent on time after being given a rent reduction.  In almost every case where the landlord verified that the tenant truly needed a rent reduction and therefore they granted one, the rent reduction did nothing more than delay the inevitable – and the tenant eventually went out of business anyway.  If you have a tenant who is paying above market rent, your property already has a vacancy rate above 8%, and you think that reducing the tenant’s rent is better than having yet another vacancy, it very well might make sense, however I would caution against giving rent reductions just because you think that this economy almost requires it of you.  As I said earlier, replacing a struggling tenant with a healthy one is often the better choice in the long run.  Leasing activity is way up and replacing those tenants who are behind on their rent is not as difficult as it was a year or two ago.