Who could have seen 2020 coming? After a record-breaking expansion phase, we simultaneously faced a pandemic and an economic roller coaster. Businesses had to close their doors—some temporarily and some permanently. Many businesses faced shortened hours and a sharp decrease in staff, while health and safety concerns became top priorities. Commercial lease agreements that were previously stable wavered in the wake of involuntary shutdowns and capital loss.
Lawsuits and rent default have been rampant this year, as tenants and landlords have faced in-the-moment commercial real estate (CRE) negotiations. COVID-19 and the resulting weakened economy are causing CRE tenants, landlords, and industry personnel to consider how to plan for the unexpected. So what can we do during the lease negotiation stage to avoid significant hardships due to future economic downturns? Here are a few of our suggestions:
Pay Close Attention to Budget When Negotiating Rent Rates
A simple way to plan for the future during lease negotiations is to stick to the budget. While there is no set percentage for a business to base their rent budget on, there is an average income-to-rent percentage per industry. For example, one source suggests that in 2018, the health and social services category had an average income-to-rent percentage of about 5.52%. If a business takes their anticipated gross income per month and multiplies it by the industry’s current average, they will have a reference for what their rent payment could be.
But markets vary—sometimes drastically. The bottom line is that businesses should review the rent rate against their budget and consider worst-case scenario numbers (as in the case of a recession). During negotiations, if the rent rate is not within a manageable range for a business, it might not be the right property for that business.
Include Language in the Lease Regarding Unexpected Costs
A business should also plan how they will handle unexpected costs. One of those costs is annual rent increases. To prevent ever-rising rent rates, the tenant can include language that places a cap on the amount of the rent increase.
Additionally, the lease should specify which party is responsible for expenses outside of the rent amount. For example, the lease should explain whether the landlord or the tenant will pay for updates regarding safety and ADA compliance. And the lease should also list who will pay for damage related to possible catastrophic events. This language will prevent either party from facing surprise costs if these situations arise.
Hire a Commercial Advisor
One of the best ways to plan for the unexpected is to hire a commercial advisor. Experienced advisors have been through CRE cycles, economic downturns, and a variety of commercial transactions. And now, they have also been through a pandemic. Their experiences have equipped them with a plethora of solutions to offer their clients. And even though each lease is unique to each landlord and tenant, they can guide their clients using best practices.
Large catastrophes such as hurricanes, recessions, and the 9/11 tragedies have all played a hand in changing CRE practices. The COVID-19 pandemic will also help shape the future of CRE. Whether lenders will add stipulations or landlords will implement new clauses in lease negotiations remains to be seen. But one element that is not changing is the importance of a commercial advisor to guide their clients through the unexpected.
Experienced commercial advisors are familiar with handling unique situations while maintaining landlord-tenant relationships. Collectively, HBRE advisors have decades of experience in CRE; they are prepared to answer challenging CRE questions. Reach out to an HBRE advisor to learn how to prepare a lease for the unexpected.
If you are interested in learning more about investing in commercial real estate, or if you have questions about buying, selling, or leasing a commercial property, please contact an HBRE advisor. Our team of experienced CRE professionals have the skills and insight to assist with all property transactions. To reach out to us directly, email [email protected] or call 615-564-4133.
