Think like a lender for a better landlord lease

Blog Post
As demand for real estate has outpaced supply in many markets, rents have risen beyond their pre-recession levels and landlords of desirable properties enjoy the flexibility to dictate lease terms. This is particularly true where the tenant is a start-up, early stage, and/or thinly capitalized venture.

It is standard landlord practice to negotiate a security deposit/letter of credit and “deep pocket” personal or parent-level guaranty. Often times the security deposit/letter of credit will “burn off” over time failing a tenant default. However, given the current market environment, I have encouraged my landlord clients to consider more aggressive covenants and security/collateral protections customarily seen in bank loan documentation.

Landlords may want to contemplate adding the following pro-landlord “lender” concepts to their leases:
  • Minimum tangible net worth and liquid cash covenants on the tenant and/or guarantor. Tangible net worth is easily defined as: tangible assets less liabilities (including contingent liabilities, if possible) in accordance with GAAP. Liquid cash is defined as: cash, certificates of deposit (with a maturity of two years or less) with any FDIC insured bank, and publicly traded stocks listed on a major exchange. Tangible assets and liquid cash should only be included to the extent owned free of all security interests, liens, pledges, charges or any other encumbrances.
  • Regular reporting of certified tenant and/or guarantor financials (including, in the retail context especially, isolated gross sales from the premises).
  • Springing letter of credit/security deposit increase triggers based on the tenant and/or guarantor’s pre-default financial performance (which may involve revenue, EBITDA, or debt service coverage hurdles per lease year).
  • Penalties for failure to open for business at the premises within a certain period of time after possession of the premises is given (especially where the tenant is performing improvement work).
  • Blanket senior first-priority, if available, or subordinated security interests in the tenant’s and/or guarantor’s assets (whether located at the premises or elsewhere) and restrictions on the tenant’s and/or guarantor’s ability to sell or transfer key assets without releasing the proceeds to the landlord to be applied toward future rental or other obligations.
  • Requiring the tenant to form a single-purpose bankruptcy-remote entity with accompanying separateness covenants (only to be used where there is a third-party “deep pocket” guarantor, of course).
  • Including expansive representations, warranties and ancillary covenants for example, and without limitation, those related to litigation, defaults under other agreements, and material adverse changes in the business of the tenant and/or guarantor.

In fairness, well represented tenants will often successfully negotiate many of the above provisions out of the final lease document. However, a landlord may ultimately be able to include some of the above points in the executed lease resulting in a superior lease. It is always important to remember that points which are deleted by the tenant in the negotiation process are merely bargaining chips for other lease provisions. 

Next time you lease space in your project, do not forget to “think like a lender.”

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