The Landlord-Tenant Dance
Failure to pay rent is the most common dispute between a landlord and a tenant, and it's a problem that is growing as the economy worsens.
"Every landlord in town right now has tenants coming to them and saying that either they can't pay the full rent or any rent, or that they're closing up shop," said Sue Springman, who has been in the real estate business for 25 years and is currently president of Executive Management, Inc.
"The economy's impact is deep; this isn't a single layer issue but a multiple layer one. When tenants don't pay, it affects property owners' ability to pay as well," she said.
Retail businesses in particular are struggling right now, and several big box giants have recently declared bankruptcy. Circuit City Stores, the number two U.S. consumer electronics retailer, filed for bankruptcy protection just a few weeks before the start of the key holiday shopping season, becoming the largest retailer to file under Chapter 11 this year. The Madison stores, however, plan to remain open.
Linens N' Things, located at Greenway Station, a mall which is showing obvious signs of distress, is another national chain that declared bankruptcy this year. That store, however, is liquidating — and has left a big hole at Greenway.
Smaller, local businesses are also feeling the pinch, either laying off workers or completely closing up shop. Second-hand clothing store Wear it Again recently announced it was going out of business, along with Star Photo, K & Y clothing store, and Moco Market.
While these company closings and setbacks are terrible for business owners, there is also a ripple effect to the landlords of these troubled commercial properties.
When a tenant doesn't pay rent, what is the answer?
Years of Free Rent?
Harvey Temkin, partner at Reinhart Boerner Van Deuren, said, "You always have problems with a tenant not making it, particularly in this economy. Take Steve & Barry's (national clothing chain, with local stores) for example. Who would have thought they'd implode? Or recently, a large national law firm imploded (Heller Ehrman). Who ever would have believed that? There are always surprises."
Oftentimes, according to Doug Buck, a lawyer at Foley & Lardner, landlords forgive rent because their presence at the property benefits the landlord. "I can think of ten instances at least," he said, "where tenants aren't paying rent and landlords are turning the other cheek until the business comes around.
"I've known a couple of businesses out there who haven't paid rent for two or three years, but the landlord likes having them there because they generate traffic for other tenants."
Temkin said he's seen situations like that locally as well. "There are certain circumstances where the tenant provides something that the landlord really needs or wants."
Buck added, "Often times, the tenant will come back and be able to pay the rent and sometimes even make up past payments. It's a business risk."
Court: The Worst Place to Be
Every lawyer and property owner interviewed for this article agreed on one thing: it's always better to work out a deal of some sort between the tenant and the landlord instead of going to court.
Temkin said, "Court is the worst place to be. It's expensive, inefficient and a waste of time. The time you spend fighting over this stuff could be spent growing your business."
Springman added, "Trying to evict a tenant is very difficult. When a landlord talks to an attorney, they are usually at their wit's end. It costs more money and oftentimes you don't ever collect, particularly if you're going after a small business that filed bankruptcy."
Ethan Miller, a lawyer with W. R. Stewart and Associates said he handled more eviction cases in 2008 than he has in the past five years total. Still, he emphasized that the vast majority of eviction or non-payment cases never go to trial.
"Generally, the law is designed to favor the tenant, which can make it difficult and time-consuming for the landlord to recover the property. Quite a few cases involve people working out a deal so the business can stay."
When Miller represents a client, he encourages them to think about a payment plan of some sort for the tenant.
Bradley Hutter, president of MIG-Properties, which has around 45 tenants, said he's never evicted a tenant in the 15 years he's been a landlord.
"We start with the proposition that, in most cases, a landlord doesn't want a tenant to move and vice versa. We always encourage tenants to come to us when they're experiencing problems — the earlier the better — so that we can propose options, such as rent credits, in exchange for extending a lease."
MIG's model, according to Hutter, is focused on creating a partnership with its tenants, and keeping the lines of communication open, "rather than being reactive or collection-oriented."
Hutter believes that a lot of landlords would like to approach tenants in this way, but sometimes there are other issues involved.
"Banks can have certain requirements for leasing. Or, there's an ownership group of multiple landlords or investors so you need an agreement, which makes it harder to craft something creative. This gives even well-intentioned landlords some boundaries."
Before the bankruptcy law was changed in 2005, companies who went bankrupt under Chapter 11 (reorganization) were able to stay in their current space for an undefined period of time.
Buck said, "A company might have been able to occupy a store for a year or more while it decided on their business plan."
Springman gave an example of a tenant (not with EMI) eight years ago that was part of a national retail chain which declared Chapter 11. The retailer closed certain stores around the country and kept others open, a common occurrence.
"We had one they were closing," said Springman. "And until reorganization occurred we weren't allowed to lease the space. That space was empty longer than a year!"
The change in the law now gives a company 120 days only to accept or reject the lease. "That's better," said Springman. "But it's still a long time."
Big Box Issues
Buck, who dealt with the K-Mart bankruptcy in 2002, said a common problem arises when the tenant does leave: leasing that space which was built specifically for the former tenant.
"Modern retailers tend to like new buildings. Also, a Gander Mountain won't move into a Best Buy store, for example. A national retailer wants their store built in a particular way. They might need a certain amount of storage versus showroom space, and they want the stores to look the same across the country.
Springman said another issues she's seen arise when dealing with a national retailer, is collecting rent. "They can be difficult to collect from because they put language in their leases that drags out the payment of that expense for six months or longer.
"I swear it's an internal corporate tactic to manage cash flow, and it's disturbing. There are a lot of big retailers who do this, continually question expenses, then drag out payment with back and forth."
Other Landlord Worries
Another issue that landlords have to deal with is construction liens. If a tenant doesn't pay a contractor, they can go to the landlord to collect. The idea behind this is that the work the contractor did for the tenant improved the landlord's property, so the landlord should be liable.
"It isn't a bad idea," said Springman, "but most of the time the 'improvements' are useless. What the tenant has had done is often not useful to the next tenant. If we don't need the improvement and aren't going to use it, why should we have to pay for it? State law is bad for the landlord on this. I strongly feel the Wisconsin legislature should clean this up; it's not fair."
The Biggest Tenant Mistake
Not reading the lease is the biggest mistake Temkin sees tenants making over and over. "You can lose a lot of money by not paying attention to the lease. It will cost you in the end."
He estimates that close to 70 percent of business owners do not have a lawyer look over their lease. He admits that it can be expensive to have a lawyer read through a 40-page lease. "But you'll find stuff in there that's just abominable.
"For example, say you're a single user in a building, and the landlord has a provision that any time the roof wears out, the landlord can repair it and charge the tenant. Say it's the ninth year of the lease and the tenant's just getting ready to leave, and the landlord suddenly decides the building needs a new roof."
Temkin said that type of problem can be avoided if the lease is negotiated beforehand. "The problem is," he added. "Once you've signed it, it's hard to get out of it."
Temkin also recommends checking out your landlord before signing a lease. "It's amazing what you can find out today. Due diligence can be done very easily, and the time spent is worth it."