What To Do When an Office Tenant Stops Paying Rent
Twitter is a widespread social network, and it’s got a vast office portfolio to match, spanning about 25 office locations worldwide.
And under new CEO Elon Musk, Twitter made a bold choice not to pay rent on any of that space, presumably in a bid to renegotiate its leases and continue cost-cutting measures. At least one of Twitter’s office landlords, in San Francisco, has since responded by suing to collect unpaid rent. Another in Singapore reportedly escorted Twitter employees out of the building.
Twitter’s gambit comes at a time of nearly historic uncertainty for office landlords. The national office market has reported negative net leasing absorption in seven of the past 10 quarters, and there is a record amount of sublease office space available, according to CoStar, the publisher of LoopNet. CoStar projects the national office vacancy rate to reach a historic high of 13.6% by the beginning of 2024.
These conditions will likely lead to more landlords who aren’t positioned well enough to evict tenants, even if they’re not paying rent, said longtime New York-based real estate lawyer Daniel Gildin of Kaufmann Gildin & Robbins LLP.
“We’re in a pretty unusual space right now,” Gildin said. “There are almost no rules.”
Still, there are ways office landlords can protect themselves from delinquent tenants, even in a soft market. It begins with how the lease is negotiated in the first place.
Choose Your Tenants Wisely
It may go without saying, but securing a financially responsible, trustworthy tenant is a paramount first step to stabilizing an office building. Finding a tenant with a promising long-term outlook is key as well.
In addition to scrutinizing the company's financial information closely, it's not uncommon for property owners to request personal financial statements from individuals with an ownership stake in the business.
Even then, “Having a financially responsible tenant doesn’t mean that that tenant won’t cease to be financially responsible two years later,” Gildin said.
Get As Much Rental Security As You Can
Like lenders, every commercial landlord will ask new tenants for rental security upfront as collateral. How much security is dependent on myriad factors like the characteristics of the office space, the characteristics of the tenant, the tenant’s creditworthiness or the length of the lease. Asking for at least three months of rent is common in the New York office market, Gildin said. Six months isn’t outrageous.
The ‘Good Guy Guarantee’
Another common safeguard in office leases is the “good guy guarantee” clause, which is self-explanatory, Gildin said.
“It’s ‘be a good guy and don’t stay in my space if you’re not going to pay me the rent,’” he said. Moreover, the individual that endorses the guarantee becomes personally responsible for the rent and cannot hide behind the shield of a corporate entity or LLC. This personal liability and exposure of assets will usually make a tenant less likely to default on the lease.
Other common provisions in these clauses include providing three to six months’ notice if vacating a space early, ensuring payment of rent due until then and leaving the space in good condition. Guarantors of the lease only relinquish their personal guarantees on the space if all these clause conditions are met.
Sometimes, tenants transgress though, especially in troubling economic times. In which case …
“There are deals that can be negotiated. It depends on who’s got money, who needs money, how fast they need money, and whether there are alternatives."Daniel Gildin, attorney
How To Deal With Unpaid Rent
In a stronger market, an office landlord can just tell a non-paying tenant to leave because it’s easier for them to find a new tenant. But when the market is weak, the landlord must make other choices, at least if they believe the tenant has the ability to pay. Mediation or arbitration with a third-party negotiator is usually not the ideal approach because unpaid rent is a simple financial matter, Gildin said.
The ‘Acceleration Provision’
Another tool often used by lenders that can be written into office leases, acceleration provisions allow the landlord to require all rent payments due prior to lease expiration when the tenant is in default (for unpaid rent or otherwise breaching the rental agreement).
“If you have five years left on your lease and you are in default, I can declare you in default and declare the entire next five years to be due and sue you once, and sue you for the entire five years,” Gildin said. “If there’s no acceleration provision, then the landlord’s got to sue for what he’s owed, say four or five months, then probably amend their lawsuit five months later to maybe 10 months [unpaid rent] and amend their lawsuit again and keep going.”
But filing multiple lawsuits to collect rent may be unreasonable, at least in New York, given the current court case backlog, Gildin said.
Summary Proceeding
Summary proceedings are an expedited legal maneuver in which the landlord could ask a court to demand the payment of unpaid rent or eviction of a tenant in default. Typical legal procedures, such as the discovery of evidence, are waived to expedite a ruling.
Reaching a Settlement, or Buying Time?
Oftentimes, especially in a soft market, there’s not much an office landlord can do other than negotiate a deal with their tenant.
That means a settlement, which means compromise. And how much to compromise is another dynamic that depends on multiple variables.
“There are deals that can be negotiated. It depends on who’s got money, who needs money, how fast they need money, and whether there are alternatives,” Gildin said.
If the tenant has proven to be trustworthy in the past, a landlord could let the tenant pay discounted rent for a few months and let them make up the difference later. If the tenant can’t be trusted, then such deals are a useless exercise.
The landlord’s debts play into this equation as well. A landlord with little to no mortgage can sit on vacant space to find an ideal tenant, especially if there are tax advantages. A heavily leveraged landlord might need to borrow off equity from another building in their portfolio to buy time on an underperforming building.
“But that is probably not a long-term solution,” Gildin said.
Though high-profile, the rent dispute between Twitter and its office landlords is not uncommon. And with an abundance of space to choose from, tenants seem to have the upper hand right now when it comes to the office market. But again, the best step may be to vet tenants in advance and put contractual safeguards in place while negotiating the lease, to avoid surprises later.
