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Wednesday, Apr 24, 2024

Real Estate Strategies For Tomorrow’s Workplace

Who are the most important players that should make up your real estate team?

TINDALL: Going forward, owners may need two teams. One team contains traditional advisors: attorney, banker, accountant, broker, and property manager. This team handles matters impacting cash flow, such as renegotiating leases, applying for emergency funds, and identifying favorable tax saving opportunities. To provide a safe environment, owners and tenants will need to designate a team to coordinate and execute important tasks, such as:

• Establish and implement safety guidelines to be followed by all visitors;

• Posting signage showing the guidelines all must follow before entering the building;

• Monitoring how many people enter, so businesses comply with social distancing standards;

• Maintaining a supply of hygiene products, such as hand sanitizer, soap and paper towels;

• Frequent sanitization of high-touch surfaces, such as door knobs, restrooms, elevator buttons, stair rails, kitchen appliances, phones, etc.; and

• A point of contact person to communicate between landlords/tenants.

As businesses reopen, there are many important team members.

How has your role changed from that of being a dealmaker, to that of a trusted advisor?

BRAINARD: My role as a trusted advisor is about coming from a place of authenticity, vulnerability and transparency. It means investing whatever time is necessary to truly get to know each client personally, understanding their business, what matters most to them, and what keeps them up at night. This means asking the right questions, talking far less and listening far more…really listening to them. This role is not transactional or driven by fees. Rather, it is driven by coming from a place of high intent, and always looking for ways to help my clients solve business issues.

LURIE: I think my clients considered me both a dealmaker and trusted advisor before the COVID-19 pandemic. That said, I think clients are valuing trusted advice now more than ever. I have been advising both landlords and tenants on lease modifications, impacted property owners on loan modifications, small businesses on forgivable loans under the Paycheck Protection Program, and companies on business interruption insurance claims.  Clients are also looking to me for up-to-date advice on how re-opening their businesses can be done in a way that is safe, cost-effective and in compliance with a myriad of new overlapping laws.  These matters require sound business judgment, and many involve a rapidly changing landscape of local, state and federal legislation. 

What are your clients telling you about their ‘getting back to the office’ challenges?

TINDALL: The biggest challenge my clients face is the uncertainty of this situation. We are all in uncharted territory dealing with this new virus. Following the directives to reopen businesses in phases means clients are reopening on a limited basis. Social distancing requirements limit persons allowed to enter facilities, and productivity and revenue may not recover to pre-Covid19 levels soon. Those same distancing requirements may also trigger a need for additional tenant space. The virus is still circulating in the community, so adherence to safety guidance is important to minimize continued spread of the disease. Experts mention a “second wave” is likely during the winter flu season. If another outbreak occurs, it is hoped that everyone will quickly reinstitute current safety protocols, such as wearing masks and social distancing. With a collective effort, we can avoid another extended shutdown of businesses and prevent the tragic loss of lives.

Should tenants be aware of any tax issues if they enter into a lease modification or restructuring with their landlord?

SANCHEZ: There are usually no tax consequences from a lease modification (or default), but if there are “substantial modifications” (i.e., “economically substantial”) to the rights, obligations, or payments under the lease, Internal Revenue Code § 467 may come into play. At the risk of oversimplifying very complicated rules, IRC § 467 applies to deferred rent, prepaid rent, or stepped rents (increasing or decreasing) that exceed $250,000 over the (modified) lease term. Many common modifications do not qualify as substantial under safe harbors set forth in the regulations. If a lease becomes subject to IRC § 467, tenants may have to alter how they account for rent payments. For example, if a tenant negotiates a deferral of rent into a subsequent year, such deferral may be reclassified as a loan and a portion of the rent may be deemed interest, the deduction of which could be limited under IRC § 163(j).

How are you anticipating workplace strategies changing? How will companies use their space differently moving forward?

TINDALL: The workplace may never be the same, since current safety guidelines still advise that only essential employees should return to the workplace. Businesses are advised to encourage employees to work from home, if possible, and will likely continue to do so even after safety restrictions have been removed. First, it still helps with utilizing existing space in a safe way. Second, many businesses have already dealt with the pain of transitioning their workforce to a WFH environment. Employees are becoming more comfortable working this way, and are returning to their usual performance levels. Third, working from home is becoming more commonplace, and is a way to retain employees (especially those who have to endure long commutes). Procedures will likely stay in place for the foreseeable future concerning how to accept deliveries, limiting visitors/customers, creating marked footpaths for social distancing, and providing sanitization supplies.

Some experts are predicting massive downsizing of space, while others are predicting expansion to account for social distancing in the workplace. What are you hearing from your clients?

BRAINARD: We are still in the very early days of re-inventing what the workplace of the future will look like. We are hearing different things from different clients. One of the most recurring things clients are saying is that they have validated they can be very successful and productive with their employees working from home. This has boosted client confidence in their ability to adapt, and to be flexible and nimble as a business. This also suggests the potential for clients to thrive as a business with a smaller space footprint than previously contemplated. On the other hand, we are hearing from many clients that in-person collaboration is key to cultivating company culture, innovation and productivity. If this is truly the case, we may see some companies decide an increased space footprint is necessary. It is far too early to tell, and will differ for each company.

TINDALL: Most of my clients are hopeful that society will return to some level of normalcy, and feel their workspace fits their current needs. Some may consider a lateral move to a more favorable location if the market conditions are right. Some are considering an upgrade to a larger facility to meet social distancing standards. Most plan to continue WFH practices, and are assessing if the unused space left by remote workers satisfies the social distancing requirements. Significant unused space may lead to cost effective considerations of subleasing or downsizing. Those businesses that require “all hands on deck” may have to consider expanding the workspace to provide safe working conditions. Unfortunately, some businesses will be closing their doors forever. There will be properties available in several sizes. As we reopen, the confidence level of businesses and the public will play a role in the timing and volume of any re-sizing transactions.

How are building owners and tenant looking at shifts in priorities? (i.e.: HVAC systems with more effective air filtration systems, crowded elevators versus stairs, high rises versus low rises, etc.)

BRAINARD: Tenant priorities are shifting to a heavy emphasis on the health, safety and overall well-being of their employees. While these things have always been important to most companies in the past, they are even more critical today. As such, tenants are going to be much more cautious when conducting their up-front diligence on their current buildings when considering a lease extension and on other buildings as they evaluate their space relocation scenarios. Things such HVAC systems in compliance with more rigid air filtration standards, more efficient building ingress and egress, safer and more hygienic common areas, operable windows enabling fresh air circulation, more outdoor areas, enhanced janitorial cleaning standards, etc. are just a few examples. Additionally, we will see a “flight to quality” as tenants use the current shift in the market to either relocate to better quality buildings or improve their existing building to a higher standard.

TINDALL: Owners and tenants want a safe environment for everyone entering their buildings. The most effective way to accomplish this is by following official health guidelines. Maintaining social distancing throughout the building, including elevators and stairwells reduces the chances for Covid-19 transmission. Requiring people to wear masks, advising frequent hand washing, and to wiping down high-touch items after use are proven methods to reduce virus transmission. Screening people for symptoms of fever before entering may become more common, as well as employers telling employees not to come into the office if they are feeling sick. As for HVAC systems, many owners have had air ducts cleaned and new filters installed. While there is no direct scientific evidence of any benefit, it is believed the HVAC system can mitigate some of the exposure risk due to the ability of some filters to remove Covid-19 particles from the air.

What are the options available to tenants for renegotiating their existing leases?

LURIE: While force majeure clauses and governmental legislation may allow tenants to delay performance, the legal position for termination or renegotiation of their leases is often tenuous.  Therefore, it is usually important for tenants to try to identify a “win-win” proposition for landlords.  This may take the form of a lease extension, a credit enhancement such as a guaranty, or for a shopping center tenant, comfort regarding the tenant’s continued operations.  That said, if California Senate Bill 939 becomes law in the form approved on May 22, 2020 by the Senate Judiciary Committee, leverage in lease renegotiations for restaurants, bars and entertainment venues that meet specified financial criteria will dramatically shift, and the threat of a “lose-lose” proposition from lease termination will likely take precedence over finding a “win-win” scenario.  

BRAINARD: The options available to tenants for renegotiating their existing leases depend on many variables. Now more than ever, as the tables have turned to a tenant’s market, landlords are going to look for ways to stabilize their buildings. The key to this is keeping their existing tenants in place and partnering with them to ensure the tenant’s business succeeds and thrives, not only in the short term, but over the long haul. When renegotiating a lease, there may be opportunities to immediately achieve certain business objectives, such as reducing a tenants occupancy costs, improving its space to create a better and safer workplace environment, improving the building mechanical and technology infrastructure, and create more flexibility for its business to expand and contract its space footprint.

What are the benefits and drawbacks of abatement, deferment, and/or extended terms in exchange for immediate concessions?

LURIE: Striking a balance between the competing financial interests of landlords and tenants is key in determining any concession.  Landlords need rental income to pay debt service, property taxes and operating expenses.  Deferment delays this income and abatement cancels it, putting loan covenants in jeopardy.  Tenants need business income not only to pay their rent, but also to pay employees, vendors and suppliers.  Abatement is a lifeline for tenants while deferment bides them time to pay back increasing debt despite reduced revenue.  An extended lease term may increase certainty and provide stability for both parties, but only if a tenant is financially positioned to weather the full impact of the crisis.  A decision on what relief to provide should be made on a case-by-case basis after considering, among other things, financials of the tenant, its business plan for emerging from this crisis, and the impact a vacancy may have on the overall project.

What’s the best way to understand your particular landlord’s motivations? How can they help you in your own negotiations?

LURIE: As an attorney who represents both landlords and tenants, I think I have insight into the motivations of both.  Landlords are interested in preserving the bargained for rental income stream that allows them to pay debt service, property taxes and operating expenses, build reserves for future capital expenditures, and make distributions to their investors.  In retail projects, landlords want high occupancy levels and a proper tenant mix. Landlords also need to comply with their loan documents, which often prohibit rent reductions or other material lease modifications without the lender’s consent. If a commercial tenant offers more long-term value or certainty, whether in the form of a lease term extension or a credit enhancement such as a personal guaranty, or if a shopping center tenant offers comfort regarding continued operations, then landlords and their lenders will be more flexible in meeting tenants’ short-term needs. 

The CARES Act allows for a proportion of funds to be used to pay rent. What do tenants need to know about this?

SANCHEZ: The CARES Act included two loan programs, the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL), both of which are available to eligible tenants (generally businesses with 500 or fewer employees, as well as certain nonprofits). PPP loan proceeds may only be used for certain expenses, including payroll costs, mortgage interest, rent, utilities, and interest on preexisting debts. If certain conditions are satisfied, loan proceeds used to pay these expenses over the 8-week period after loan origination may be forgiven. The Small Business Administration (SBA) issued guidance indicating that only 25% of the loan may be used for eligible non-payroll costs, including rent. Tenants should be very diligent in tracking these expenditures to ensure that they will be eligible for forgiveness. EIDL proceeds may also be used to pay rent, but cannot be used to cover the same expenses as a PPP loan if they received both.

TINDALL: The CARES Act created the PPP. This program was designed to provide financial assistance in the form of forgivable loans, and help employers retain their workforce during the Covid-19 stay at home orders. Borrowers are eligible for loan forgiveness if the proceeds are used during the 8-week covered period (beginning on the date of the first PPP distribution) to pay qualifying costs. The Program’s rules and computations are complex. In simple terms, borrowers should expend at least 75% of the funds on qualifying payroll costs, while also maintaining a comparable full-time equivalent workforce during the covered period. The remaining 25% (or less) of the funds can be used to pay non-payroll costs consisting of business mortgage interest (but not principal), rent/lease payments, and specified utilities. To allow for easier tracing of expenditures, it is advised the PPP loan funds be deposited into a separate bank account.

LURIE: The CARES Act currently allows loans obtained through the Paycheck Protection Program to be used to pay rent for leases in force before February 15, 2020, as long as the rent payments are either paid or incurred during the 8-week period after the borrower receives the funds.  However, currently only 25% of the borrower’s forgiveness amount can be used for rent.  That means that every dollar over that 25% threshold spent on rent is not forgivable and must be repaid to the lender.  On May 28th, the House of Representatives approved a bipartisan bill to extend the 8-week limitation to 24 weeks and increase the 25% threshold to 40%. That bill now goes to the Senate. Whether under the law as currently drafted or as it may be amended, Tenants should consider how important it is to maximize their forgiveness compared to their potentially competing need to meet rent obligations.

Did the CARES Act “fix” Qualified Improvement Property (QIP) depreciation?

SANCHEZ: Yes. The Tax Cuts and Jobs Act of 2017 (TCJA) created the QIP classification (replacing Qualified Leasehold Improvements, Qualified Restaurant Property, and Qualified Retail Improvements). QIP (improvements made to the interior of a non-residential building placed into service after the building itself) was intended to be classified as 15-year property (depreciable over a 15-year recovery period) and eligible for 100% bonus depreciation (immediately deductible instead of capitalized and depreciated over time). However, due to a drafting error, it was instead classified as 39-year property and not eligible for bonus depreciation. The CARES Act includes a technical correction with respect to all QIP placed in service after 2017, retroactively classifying it as originally intended. The IRS issued Rev. Proc. 2020-25, which allows taxpayers to file an amended return, administrative adjustment request (AAR), or Form 3115 (Application for Change in Accounting Method) to change the depreciation of QIP placed in service in 2018, 2019, and 2020.

What’s the best way to stay current on opportunities for future assistance programs?

TINDALL: CBIZ MHM has a dedicated Covid-19 Resources webpage, which can be accessed at cbiz.com/insights-resources/covid-19-resource-center. This webpage provides current information on a wide range of Covid-19 related topics, such as tax law changes, human resources concerns, risk advisory matters and financial assistance programs. The webpage is constantly updated, so everyone can keep abreast of new assistance programs or any other federal legislative actions that can provide cash flow. The webpage also contains articles and recorded webinar events that help explain the complex rules associated with the various economic relief programs and recent taxpayer-friendly changes in tax laws. Other resources are the websites for the State of California found at covid19.ca.gov, and Los Angeles County found at corona-virus.la. These websites provide guidance to California businesses ranging from which businesses can be reopened, limitations imposed on reopened businesses, and toolkits (checklists) to maintain a Covid-safe business environment.

SANCHEZ: Follow your trusted advisors’ websites and social media. These professionals are constantly monitoring developments, thinking about how changes apply to their clients, publishing articles and updates, and participating in educational events to keep interested parties apprised.

Some companies are downsizing and have too much space. Is subleasing unneeded space a
good option?

BRAINARD: We are currently seeing a large volume of subleases hit the market. This trend was ticking up before the pandemic hit. The pandemic has only accelerated this trend and the percentage of sublease space going on the market significantly. We are also seeing a large increase in “shadow space,” which is space that can be made available to lease or sublease but is not yet technically on the market. Whether or not subleasing space is a good option for a tenant depends on several variables. Sometimes there may be other strategies that could be more effective or yield better results for the tenant. Therefore, it is important to always seek the counsel of an experienced tenant advisor who has successfully been through multiple down-cycles and transitioning commercial office markets (i.e. landlord market to a tenant market, etc.), who can help you consider all possibilities that might be best for your business.

LURIE: Whether due to the downsizing of their workforce or because working from home is not as disruptive as previously thought, some companies are finding that they can operate with less office space than they used before the COVID-19 pandemic.  While Subleasing is one viable option for those tenants, they should consider several issues. A tenant should check if subleasing is permitted under its lease and whether landlord consent is required.  Its lease may require the tenant to share with its landlord any profits the tenant realizes from its sublease.  The tenant needs to consider the costs associated with subleasing, such as brokerage commissions and the cost of subtenant improvement work.  Finally, because of the effect of the pandemic and associated government mandated shutdown on the general economy, it may be difficult for a tenant to find a subtenant.

TINDALL: Subleasing can be a good option if the right conditions exist. Tenants should carefully assess their own space needs, with special consideration for social distancing requirements. If excess space exists, subleasing can help alleviate some of the financial burden. However, it could introduce additional complexities. Sharing space with any sublease tenant requires addressing many concerns, such as:

• Ensuring social distancing policies are maintained;

• Who and how will persons access the building;

• How will deliveries and visitors be handled;

• Communication between the parties in the event an employee tests Covid-19 positive;

• Safe use of any common areas, including elevators, kitchens, seating areas and restrooms; and

• Remedial procedures if one party repeatedly violates the above safety protocols.

There are more issues to consider, including the actual financial terms of the lease and potential leasehold improvement costs. Tenants don’t lack options, and will be considering subleases, downsizing, or just staying put.

If a tenant obtained a PPP loan and it is forgiven, will the tenant have cancellation of indebtedness income subject to taxation?

SANCHEZ: No. The CARES Act provides that forgiven PPP loans will not result in cancellation of indebtedness income to borrowers.

If a tenant obtained a PPP loan and it is forgiven, may the tenant also deduct the expenses for which the PPP loan was used.

SANCHEZ: No. The IRS issued guidance on April 30, 2020 in the form of Notice 2020-32, which provides that no deduction is allowed for an expense paid with a forgiven PPP loan. For example, if a tenant uses a PPP loan to pay rent (and satisfies the other requirements to be eligible for forgiveness), such rent expenses may not be deducted on the tenant’s income tax return even though rent would otherwise be an ordinary and necessary business expense. According to the IRS, this prevents a double tax benefit and is consistent with Internal Revenue Code § 265 (a)(1), which disallows a deduction for expenses paid with tax-exempt income. While this conclusion follows long-established tax law principles, it is also logically contrary to the purpose of the PPP. As a result, we may see legislative action with respect to this issue in the future.

What types of strategies would you recommend to business owners who are currently negotiating or thinking about new leases? What types of concession can one take advantage of?

LURIE: When negotiating new leases, business owners d engage a top-flight real estate team, including a broker and a real estate attorney, who understand both legal and business concerns.  An experienced broker and attorney will be able to advise tenants on what type of concessions are customary and protect tenants from potential pitfalls.  Many anticipate that the leasing market will soften due to an economic downturn triggered by the pandemic, which would give some tenants leverage to negotiate concessions in new leases that landlords were previously unwilling to provide.  For instance, a retail tenant may be able to require that its obligation to pay rent be deferred, discounted or converted in whole or in part to percentage rent if it is unable to be fully open for business due to a resurgence of Covid-19.  Until now, almost all leases require tenants to pay rent regardless of any force majeure event. 

SANCHEZ: Tenants should be cognizant of tax issues related to leasehold improvements. The tax consequences generally depend on which party pays for the improvements and which party owns them. For example, tenants who negotiate a cash allowance from a landlord for improvements they will own will recognize income in the amount of the allowance. If the parties structure the lease to comply with the safe harbor provisions of Internal Revenue Code § 110, this can be avoided. Under the safe harbor, the lease term cannot be more than 15 years, the lease must specify that the allowance may only be used to improve real property used in the tenant’s trade or business, and certain disclosure must be made on the both party’s tax returns. The landlord will be deemed to own the improvements, which revert at lease termination.

Do city or statewide legal constraints exist that protect and/or prevent a landlord from evicting a tenant?

TINDALL: Los Angeles County has implemented a temporary eviction moratorium for residential and commercial tenants in unincorporated cities within the region. The eviction moratorium was recently extended to June 30, 2020, and can be extended further if emergency conditions still exist. Certain tenants are excluded from the eviction protections: multi-national companies, publicly traded companies, and companies with more than 100 employees. Several incorporated cities in the Los Angeles region have their own eviction moratorium rules. A comprehensive listing is at dcba.lacounty.gov/noevictions. There is plenty of interest in the fate of California Senate Bill 939. The Bill was recently passed out of the state’s Senate Judiciary Committee, and offers very broad protections to small business tenants. Qualifying tenants would be allowed to break their lease obligations without penalties if good faith negotiations with landlords are not settled after 30 days. The Bill could have substantial impact to property owners.

LURIE: California as well as numerous counties and cities in California have enacted pandemic-related eviction moratorium orders.  The California statewide order prohibits landlords from evicting residential tenants, while the local orders typically prohibit landlords from evicting both residential and commercial tenants, in each case when the tenants are unable to pay their rent due to the pandemic.  The local orders also typically allow tenants to defer rent payments while the applicable Covid-19 emergency orders remain in place.  The time period for commercial tenants to pay deferred rent is typically 3 to 6 months after the emergency orders end.  Also, new California Senate Bill 939 is currently under review by the legislature.  If enacted in the form approved on May 22, 2020 by the Senate Judiciary Committee, SB-939 will provide an unprecedented opportunity for restaurants, bars and entertainment venues that meet specified financial criteria to renegotiate and terminate their leases. 

How can one quickly understand if a force majeure clause in their lease is applicable?

LURIE: A tenant should first determine whether the Covid-19 pandemic or a government ordered shutdown is an event that is covered by the force majeure provision.  In many instances, the answer will be “yes.” While pandemics and shutdowns typically are not specifically identified in force majeure provisions, many force majeure definitions include catch-all language, such as “other events beyond a party’s reasonable control,” that covers these events.  If the force majeure provision is applicable, the next step for the tenant is to determine which of its obligations are excused or deferred due to the force majeure event.  Generally, force majeure clauses excuse or defer non-monetary obligations, but do not affect a tenant’s obligation to pay rent, even if the tenant is unable to open its business. Tenants should also be aware that California Civil Code Section 1151(2) may afford them with force majeure protections.

What keeps you up at night?

TINDALL: Sleepless nights are common during these trying times, especially for property owners. My clients owning residential rental properties have indicated they haven’t experienced significant delays in rental receipts. That is likely a factor of their tenants receiving stimulus checks, expanded unemployment benefits or wages from employers that continued operating or had access to PPP loans. However, clients owning commercial properties have seen 30% or more of the tenants unable to make their lease payments. The debt service for these property owners is still ongoing, and has led to a national surge in debt relief requests to lenders. Hotel owners have been particularly hit hard. Business travel is still limited, and video conferencing is now the standard. As society reopens, hotels are still experiencing very low occupancy rates. Some of my clients in the hospitality industry have said it’s actually more cost effective to remain closed. That can cause nightmares.

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