California Bill Allowing Small Business Tenants to Terminate Leases Advances in Senate

A California Senate bill that would implement a statewide moratorium on commercial evictions and allow some tenants to renegotiate or walk away from lease agreements has taken another step toward putting the state in a position to regulate commercial leases.

Drafted as a way to help prevent a massive wave of commercial evictions spurred by the effects of the coronavirus pandemic, the bill was approved by a 5-1 vote in the state's judiciary committee hearing on Friday. If it advances through the subsequent committees, it would be scheduled for a Senate floor vote in late June and possible implementation as early as September. Building owners are threatening a court challenge if it is passed.

The bill, introduced by San Francisco Democrat Sen. Scott Wiener and Los Angeles Democrat Sen. Lena Gonzalez, would freeze commercial evictions as they relate to the coronavirus pandemic. It includes provisions that would allow some tenants to renegotiate the terms of their leases. Restaurants, cafes, bars and other small businesses, currently defined as having fewer than 500 employees, would be able to negotiate for rent abatements, rate decreases, deferrals or even terminate a lease altogether.

"Due to COVID-19, California faces the very real prospect of a mass extinction of small businesses and nonprofits not just shutting down for the shelter in place, but permanently closing," Wiener said at the hearing. "This bill will attempt to prevent this from happening by, in a good faith way, trying to triage a horrible situation and prevent these mass evictions."

California is home to almost 4 million small businesses, which employ almost half of the state's workers, according to Small Business Administration estimates. The coronavirus pandemic has brought the state's economy, one of the largest in the world, to a near shutdown in the nation's most populous state. Businesses have been forced to close or operate at limited capacity since, and many have struggled to come up with the monthly rent.

Lawmakers have stepped in with a goal to provide small businesses with the resources to adapt to the new economic reality. The bill, known as state Senate Bill 939, is the first legislation of its kind during the coronavirus pandemic and an unusual step that lawmakers say they are allowed to take under the current state of emergency order.

The bill has garnered fierce opposition among landlord, lender, brokerage and real estate groups throughout the state. Many in the commercial real estate industry argue that the measure moves the burden onto the shoulders of landlords and lenders. They argue that the bill could have a devastating long-term impact on investor interest and future development in the state.

"It's hard to come up with a straight-faced response to this because it's that extreme," Matthew Hargrove, the senior vice president of government relations for the California Business Properties Association, told CoStar News. "This will have a disastrous impact on our industry."

Under the proposed bill, businesses that have lost 40% of their revenue or are operating at reduced capacity would be protected from eviction. Publicly traded companies would not be eligible, and the protections would expire by Dec. 31, 2021, or two months after the declared state of emergency ends, whichever is later. Once the emergency order is lifted, tenants will have up to 12 months to repay any back rent they owe.

Prior to the vote, Building Owners and Managers Association International chair Sarahann Shapiro told the committee that the bill was unconstitutional, and was joined by other opponents in saying it would be taken to court if it advances further.

Shapiro said the association is currently pursuing amendments that would help balance the bill, including stipulations that any deferred rent be prorated to a tenant's lost revenue or that late fees should be reimplemented if a tenant doesn't adhere to a previously agreed upon payment schedule.

Declining Values

For many brokers, even an amended version of the bill goes too far, and would threaten California's commercial real estate industry for years beyond the pandemic's duration.

"This is addressing an easy-to-sell problem but missing all of the fundamentals," Colliers Senior Vice President Stephen Rusher, based in the San Francisco Bay Area, said of the legislation. "It's easy to point to the landlord as the big, bad guy, but when you look at the relationship between a landlord and their tenant, the most successful ones are built on trust. This legislation is based on metrics that don't provide an accurate look at what's going on and is not a way to conduct business."

He said the legislation could directly impact the book value of real estate, if landlords and investors are not able to faithfully rely on tenants' ability and willingness to pay rent. "It would be a waterfall effect of landlords not being able to work with tenants and not being able to work with lenders because they can't predict their income a year in or a year out."

Brokers have said in addition to inaccurately valuing a property or lease, the bill would have a devastating impact on investors' interest in California altogether.

Pam Mendelsohn, a retail partner with San Francisco-based Maven Commercial, said the Bay Area already has a number of hurdles few investors are willing to endure, and if passed, the bill would dramatically change future development in the city.

"No one would buy property here and few want to buy property here now," she said, citing recently approved legislation like San Francisco's retail vacancy tax and its notoriously expensive permitting process. "No one would want to develop here or put money into rebuilds or new construction, and I can't even imagine how hard it would be to do a deal with a tenant that wasn't qualified. There are a lot of unknowns, but someone really needs to look at what the long-term effects of this would be."

Since the state's emergency order was implemented in early March, individual cities have crafted their own commercial tenant protections and landlords have worked with tenants on a case-by-case basis. With SB-939, Rusher said it attempts to create a blanket solution for an industry that can't operate on a one-size-fits-all basis.

"You can't create a situation where the government comes in between a landlord and tenant to change the rules of the game midstream," he said. "There's no doubt that tenants are in trouble, but this creates uncertainty that would drive a massive stake through the value of California's real estate."

In an interview with CoStar News, Wiener said the legislation is just the first step in what he believes will be a longer conversation about how to help both tenants and landlords' deal with the pandemic's effects.

"This would create an atmosphere where everyone has the incentive to renegotiate rents," the senator said of the bill's intended ability to prevent a massive wave of closures and bankruptcies. "It could be a brand new lease, it could reduce rent for a year and it could create a better atmosphere for conversations many landlords are already having. It will create a more sustainable economy."