The Involuntary Landlord - Dealing with Vacancy and Lease Modifications
By Mike Baldner
(Published in the Idaho Business Review in August, 2010)

 As a result of mechanic lien foreclosures and excess space due to downsizing, many contractors presently find themselves in the unfamiliar role of landlord.

Being a landlord is complex in the best of times, but the present state of the economy makes managing tenants even more difficult.  With a glut of space available, it is a tenant’s market when it comes to vacancies.  Existing tenants also have leverage when it comes to lease modifications.  Successfully dealing with vacancy and lease modifications can make or break the value of a property.

With retail, office, and industrial vacancies at all time highs, it is critical for a landlord to be realistic when it comes to setting rental rates.  It is irrelevant what rents used to be.  Depending on the location and type of building, asking rents are often 10-50% lower than they were two or three years ago.  In order to attract tenants, rental rates must be comparable to similarly situated projects.  The best source of information will be a commercial real estate agent.  While it may be tempting for landlords to try to avoid a commission by marketing the space themselves, most landlords lack the expertise or information to market their properties competitively.  Properties that are priced too high may sit vacant for years.  Properties which are priced too low may fill quickly, but the lower rents will have adverse effects on the property’s long term value.  A commercial real estate agent can help establish a competitive rate and market your property so the maximum number of potential tenants see the property.

With the current state of the economy, landlords should be more vigilant in vetting the credit and business plans of potential tenants.  It is to be expected that most tenants’ balance sheets have been battered over the last few years.  However, before offering to construct user-specific tenant improvements, landlords should make certain the tenant has the credit and business plan required to pay the rent required to amortize such costs.  As is always the case, except for the strongest of tenants, a personal guaranty of the owner of the business should be required.

Most landlords would likely rather have the tenant pay for all improvements, but given the economy this may not be realistic.  Landlords may want to consider offering free rent in exchange for the tenant paying for improvements.  At a minimum, landlords should avoid paying for improvements that will have no value to successive tenants.

While the rent outlook is bleak for the short term, it will likely improve over time.  Landlords should avoid locking into long term rates at today’s historic low rates.  Most tenants will accept shorter lease terms which allow the landlord to increase rents when merited by market conditions.  For tenants requiring longer lease terms, the landlord should require periodic increases in rent based upon increases in market or inflation.  Additionally, landlords may consider adding a percentage rent provision to the lease, which requires a percentage of a tenant’s sales be paid as additional rent, increasing the rent as the economy improves.

Of course, the best way to avoid vacancy is to keep existing tenants.  Tenants experiencing difficulty will often approach landlords for lease modifications.  As a threshold matter, the landlord must evaluate whether the tenant can be saved and how much help is required.  Landlords should insist upon detailed financials reporting sales and expenses.  If the tenant appears headed for insolvency no matter how much the rent is lowered, there is no point in making a modification.  If it looks like the tenant could survive with a rent abatement, the landlord should make certain that as sales increase, the rent is increased as well.

The landlord should also get the right to cancel the lease in the event a prospective tenant is willing to pay more for the space during the period of rent reduction.  Finally, the landlord should insist upon an ironclad confidentiality provision related to the modification.  Once the word gets out that rent reductions are possible, even tenants without financial need will line up to ask for a reduction.

In short, when dealing with vacancy, landlords need to keep both a short and long term view in mind.   Short term, landlords should be aggressive about attracting and retaining tenants.  Long term, landlords should make sure they have not locked in rates at the bottom of the market.

Mike Baldner is a partner with the law firm Meuleman Mollerup LLP, practicing in the areas of real estate law and business law.  Mr. Baldner can be contacted at 208.342.6066 or by email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .  More information at www.lawidaho.com