Tenants Increasing Calls to Alter Rent As Economy Slows

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Tenants Increasing Calls to Alter Rent As Economy Slows

By ANTHONY PALAZZO

Staff Reporter

A growing number of distressed tenants want landlords to share their pain.

As vacancy rates rise and layoffs mount, tenants increasingly are attempting to renegotiate long-term lease deals. A few are even dusting off a potentially explosive ploy, threatening bankruptcy.

“This is more prevalent (now) than it has been in the last 12 months or 24 months,” said David Thurman, a senior vice president at Grubb & Ellis Co. in West L.A. “Clearly it’s a sign of the times.”

It’s a sensitive topic, and no one will name names, but Thurman estimates that 10 percent of office tenants in the region are seeking rent relief in one form or another.

“We have two of them in one of our Glendale buildings right now,” said Bill Boyd, a Grubb & Ellis vice president in the Tri-Cities area. The two tenants, a law firm and an insurance company, have separately opened negotiations on reducing the amount of floor space they occupy, in return for extending their leases.

While renegotiations aren’t yet an everyday occurrence, they’re on the rise nationwide as corporate tenants seek to resize operations and facilities for a slower-growth economy. At Ernst & Young, the firm’s Real Estate Advisory Services practice is preparing to roll out a campaign to help corporate clients restructure their lease obligations. “We are absolutely intent on making it an American initiative for 2002,” said Darin Buchalter, an E & Y; partner based in San Francisco.

Taking advantage

But landlords are skeptical of poverty pleas.

“It is a phenomenon that is going around in the marketplace today because people think they can get away with it,” said Tony Morales, a partner with Maguire Partners who heads up leasing for the downtown firm. “I think the good landlords are really testing the validity of each tenant’s claim.”

Nevertheless, some are dealing. “It’s happening a lot,” he said.

The simplest way for tenants to reduce their rent load is to sublet space. “They all have (that) alternative, as opposed to shifting the burden of their financial problems on us,” Morales said. For tenants who signed up at the top of the market, though, subletting at other than a discount is rare.

Other tenants are seeking to recast long-term leases, either to lower the per-foot price or reduce the amount of space. Some tenants are simply opportunists taking advantage of a soft market. Many, though, are truly in dire straits, and are trying to find ways to outlast the recession.

“What you’re having now is tenants saying, ‘Hey, business is down, sales are off 50 percent, 75 percent,'” Thurman said. “You may see a tenant step forward and say, ‘Here are my books.'”

In those cases, the landlord needs to decide whether to help the tenant by granting some relief for six months or a year, and then picking up the difference later. “I think it’s on a case-by-case basis,” Thurman said.

It’s a tough decision for the landlord. There’s appeal in holding onto a tenant, but if the rent is lowered and the tenant files bankruptcy anyway, the landlord is even worse off.

“Most of my landlord clients are incredibly firm with these guys,” said Tony Natsis, a partner with law firm Allen Matkins Leck Gamble & Mallory in Century City. “If your lease is the difference between making it and not making it, you’re probably not going to make it.”

Drastic steps

Of the options available to struggling tenants, the bankruptcy threat is the most drastic. “You can definitely get the landlord’s attention much faster, because if the tenant goes to bankruptcy, they can stop paying rent and, for a period of time, tie up your space,” Thurman said.

Nevertheless, such moves can backfire. “Once you pull that trigger, that just sets a whole series of things in motion. Anytime the tenant can talk directly with the landlord, and not his attorney, that’s usually better,” he said.

Thus far, landlords have been able to hold firm. Most defaults have been in the tech-startup space, where landlords required that tenants post letters of credit before moving in. That’s been a disincentive for renegotiations prior to a number of Westside defaults, including with now-bankrupt eToys.

“You can’t have a renegotiation just because one party wants to,” said Matthew Miller, a principal with CRESA Partners. “It’s an unusual set of conditions that leads both parties to want to deal.”

While there have been more renegotiation talks since Sept. 11, there haven’t been many deals. Frederick’s of Hollywood, which is restructuring under Chapter 11, has secured agreements to pay lower rents on many of its stores, according to sources familiar with the negotiations. (Company officials declined to comment.)

Things are beginning to change, though, due in part to weakness in the L.A. County office market. By the end of the third quarter, the overall office vacancy rate stood at 14.6 percent, up from 12.3 percent a year earlier, according to Grubb & Ellis.

And where tech was the sore thumb before, now entertainment and professional services such as consulting firms, accountants and financial services are showing softness as well, Miller said.

“There comes a point in the business cycle when things tip, so that vacancies get so high, landlords will be more reasonable,” said bankruptcy lawyer Kenneth Klee, a founding partner with Klee, Tuchin, Bogdanoff & Stern LLP.

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