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Guest Commentary by Carl Kanowsky, Esq.
| Friday, Sep 28, 2012

Carl Kanowsky, Esq.

A main concern for landlords in a commercial setting – as opposed to leasing residential property like a home or an apartment – is getting the property leased for as high a rate as the market will bear.

Often conflicting with this goal is the landlord’s concern about getting paid.

These priorities often make strange bedfellows.

Obviously, the landlord wants to get the place rented.  In the past three years, commercial real estate has hit bottom and stayed there.  Offices that previously rented for $3.50 per square foot now go vacant.  Their realistic price is likely $2.25 per square foot or even less.

What’s a landlord to do?

Well, this is what creates a tenant’s market – and a quandary for the landlord.  He’s got loans to pay off, and investors demanding returns.

Some landlords resolve this conflict by agreeing to rent the space at the lower rate, but for much shorter terms than usual – say a year as opposed to three or five years.

OK, this solves his first priority; he’s got someone interested in renting that office that has sat vacant for months and perhaps years.  But the landlord also realizes that simply having an interested prospect does not equate to a good deal for him. If he has used a real estate agent, then he probably has to pay those commissions for the entire term of the lease up front, not as he collects rent.  Now he has another expense he must add to his overhead and still hopefully take some home cash.

Then he has a nightmare.  What happens if this new tenant walks away or goes bankrupt like so many businesses are doing now?  How does he continue to get paid?

He could, and likely will, require the new tenant to sign a personal guarantee of the lease.  This definitely increases the likelihood that the rent will be paid, but if it’s not enough incentive, then what the landlord has with the personal guarantee is a right to sue someone else.

The landlord could also demand a much larger security deposit to be used if the tenant defaults.  This can work well if the tenant starts missing payments.  However, if the tenant files for bankruptcy, there is a good chance the bankruptcy court could rule that the security deposit belongs to the tenant/debtor and that the landlord must turn it over to help the tenant pay its bills.

Another option is to ask for a letter of credit.  Investopedia.com defines a letter of credit (L/C for short) as “a letter from a bank guaranteeing that a buyer’s (or tenant’s) payment to a (landlord) will be received on time and for the correct amount.  In the event that the (tenant) is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the (rent).”

Most L/Cs are irrevocable – that is, once they are issued the tenant cannot pull them back.  And since a bank will only issue an L/C to clients they believe are good credit risks, the landlord gets an added vote of confidence in the new tenant.  Conversely, if the bank won’t issue an L/C, then the landlord should look long and hard as to whether he really wants to rent to someone a bank is reluctant to back.

Assuming the tenant can get the L/C, it will likely not be part of the bankruptcy estate and the landlord can draw against it for however long it will last.  It’s an option that we may be seeing more and more.

And, yes, I will write another column on leasing from a tenant’s perspective.  Also, if you have any suggestions for future columns, please email them to me.

 

Carl Kanowsky is an attorney in Santa Clarita. He can be reached at cjk@kanowskylaw.com. Visit him online at www.kanowskylaw.com.

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