Following is a transcription of episode 13 the LeaseSmart Commercial Real Estate Podcast.
Craig: This week, I want to speak about something that could be considered controversial. When we’re done here you’ll see that it’s not. I didn’t know what to title it exactly. I called it breaking a lease but that’s not exactly what we’re talking about. Maybe we’re talking about winding down a lease or something. But the point is, sometimes your business model just doesn’t work out and this agreement that you made with the landlord . . . you just can’t fulfill it. I’ve given talks about this before and landlords first get upset from me even addressing the issue but by the end of the talk they realize “Wait, this is great information. I’m glad you’re saying that.”
My point is this: A lease is meant to be a binding document where the landlord agrees to certain things, the tenant agrees to certain things. You’re supposed to fulfill your obligations to that. Fine. No argument there.
But what happens when the business model fails and you don’t have the money for rent? This happens all the time. What does the tenant do? Many times the tenant is embarrassed, mortified etc. and they don’t know what to do. They’ll just leave in the middle of the night. Pull all their stuff out of there. Mail their keys back to the landlord and say “Hey, I’m sorry. Do what you have to do.” Well that’s the last thing you want to do. I had a call from a shopping center owner one time who said, “Craig, if they had called me and let me know they were having problems I would have let them stay in the space for free until we found a new tenant.” You see, an empty space specially in a retail center makes the retail center look bad. That’s not that unusual and so my advice when you need to break a lease is the first thing you need to do is call the landlord and say “Hey, I’m sorry. I know I owe the money. We’re not arguing about that. What I’m saying is I don’t have the money. We both have a problem. I’m no more happy about this than you are but the point is I don’t have the money. What do you want to do about it?”. By talking to the landlord, now you may have some options. They might temporarily reduce your rent hoping that your business will turn around. They might have another tenant that would take the space and it’s not such a big deal for them to let you out of the lease. Maybe your rent is even below the market. I mean there’s so many things but communicating with the landlord should be the first thing to do and then go from there.
Now, you do want to talk to an attorney too and see what your position is. You want to look at the lease and see have you personally guaranteed it. Or is it a corporate guarantee only. If you fail, I guess the corporation’s going to fail too. You can file bankruptcy and perhaps escape the obligation very easily. If you’ve guaranteed the lease then that’s a different story. If you have a lot of assets you just might have to keep paying your payments no matter what, or it’s part of the negotiation with the landlord. It will have a big effect on things. Or if you‘re willing to go bankrupt or threaten to go bankrupt, letting the landlord know you won’t have any choice unless you work something out, that effects things. You know those are all things that we need to talk about and you can talk to a real estate attorney in your state that can tell you what your rights and obligations are in that state.
There are things that we could do, but the first thing is to talk to the landlord and see if you can work something out because it’s a problem for them and they want to try and work it out too. You just never know what they can do until you talk to them about that.
N: Yeah that makes a lot of sense. As I mentioned, I used to work with residential leasing and we would encourage our tenants to do the exact same thing. If we could help them find someone else to come in right after them then we could let them out of their lease.
C: Well, that’s very true. And in commercial real estate – depending on state you’re in – I’m talking about Florida which is where I’ve done a lot of work and I checked this with the attorney, but my understanding is that if you vacate a space, the landlord is obligated to do his or her best fill the space. When the space gets filled, they need to credit you with that new rent for that time period. So your damage or lease obligation might be less than you think if they’re able to re-rent the space quickly. In fact, that’s part of the discussion you have with the landlords. What we’ve done in the past is go to the landlord and say “Hey! The space isn’t working. We need to get out of here now.” Sometimes this might be the tenant that is healthy financially and they just don’t want the space anymore for a multitude of reasons. So we can say “Look, here’s our obligation to you as determined by the lease. How about we pay you X dollars upfront right now.” Maybe we have 3 years left on the lease and we’ll say “ We’ll pay you 9 months of rent upfront. “Mr. Landlord think about this: if you’re able to lease your space to someone new in 3-6 months, you just made a bonus! This could be a good thing for you.” So you know it’s all in negotiation. I’ve got a 5 page report that I put together that I sent to these companies that will call and say “What do I do?” because I get so many calls. People are distraught and don’t know what to do. My report lists negotiable items they can talk about with the landlord, or with the attorney. There are lots of things that would make this a very long podcast if I went thru them all. But the point would be, if you can’t fulfill your obligations, the first thing is to call your landlord. I guess it may sound suddenly self-serving but let me also mention sometimes you’re so distraught at the situation and you’re not thinking straight and maybe you should call your real estate broker and let him talk with your landlord maybe he can help you sublease the space. He might be able to help you assign your lease to a new user. Maybe you can find one of your competitors that would want your business. And your space, or just the business. Maybe some money involved that would help keep the landlord happy. So there’s lots of brainstorming to do and calm thinking and communicating to do. If your mind is just all foggy because this major stress you’re under, you might want to get some help from a negotiator at some point which could be your attorney too and go that way.
Then finally, one of the things when you think about it. If your business is failing, you can tell in advance that you’re making less than you’re spending. You don’t need to wait to the very end and you’ve spent your last dollar before talking to the landlord. If you can see the future and it’s not rosy, that’s when I would start talking to the landlord. So you’ll actually have some money to help cure some problems with.
Also, if the landlord has been getting your money in full, on time, every month, then you all of a sudden say “I’m out of money, sorry”. They’re not going to believe it. They’re going to assume you’ll come up with the money somehow. Friends, family, loans, equity in your house, whatever. They can put their head in the sand and just wait for your check to arrive because somehow you’ll come up with the money and I imagine that happens a lot of times. So if things aren’t going well and you could check with your attorney on this but it seems to me you might want to start making some of your rent payments late or making partial payments so they understand the seriousness of your situation and that they do have a problem headed their way and together we’re going to solve it the best way we can.
Again, it’s nothing personal. The business is failing. I can assure you the landlord has had this happen before and it will happen again. Just read the newspapers about some big prestigious companies that have had problems in addition to the small mom and pops. So it’s just part of business life and as with most everything, accurate and calm communication would be the first thing that you’d want to do.
N: Okay! Well that’s really good advice. Thank you.
C: You’re welcome.
Closing: Alright! That’s our show for this week. We hope you found it interesting and that the information will help your business grow and prosper. If you have questions you’d like answered on future shows, contact us thru LeaseSmart.com or if you’d like expert one on one help with your lease or site selection, please contact us there also. Again that’s www.LeaseSmart.com or you can call us at 800-962-2419. Thanks! We’ll see you next week.