Real Estate, Interrupted

Joshua Stein talks about how commercial real estate can survive the COVID-19 pandemic

Joshua Stein wasn’t sure what type of law he wanted to practice until he took a Columbia Law class in commercial real estate transactions in the late 1970s. There, he learned the step-by-step rigor of real estate deals as well as the creative possibilities within those deals. He’s now one of the top real estate lawyers in one of the top real estate markets in the world, New York City, which also happens to be the epicenter for the COVID-19 pandemic. We reached out to him to get his thoughts on commercial real estate in these turbulent times.


What questions and concerns are your commercial real estate clients bringing to you during this pandemic?

We play all sides. We represent landlords. We represent tenants. A lot of tenants are in a terrible situation because their revenue has completely gone away—not just partly but completely. The assumptions on which everybody proceeded in signing leases and doing business have been completely undercut. It’s like suddenly they’re on a different planet. A risk that nobody considered has come and hit everybody.

These tenants often don’t have cash reserves. They live hand-to-mouth, even big tenants. Rents are expensive. Operating costs are expensive. The money that comes in today goes out tomorrow to pay operating expenses, and if they’re lucky there’s a couple of bucks left over at the end of the month. But there isn’t lots of money sitting in some silo somewhere so that people can pay rent for extended periods while they’re out of business. It’s just not part of the calculus.

Then you’ve got landlords with leases that are pretty tight. The tenant has an obligation to pay the rent no matter what. A lot of leases do have force majeure clauses, or unavoidable delay clauses, but those only protect the tenant if there is a non-monetary thing they’re supposed to do—like maybe they have to build a wall by a certain date. But there’s ordinarily no force majeure extension of time for paying money. You can read a thousand leases and you’re going to find maybe 800 of them have a force majeure clause, and of those 799 say, “The force majeure clause does not apply to the payment of money.”

Some landlords are accommodating tenants in certain ways. The typical deal is you look at two or three months of rent, and you let the tenant pay that rent later. You defer it. But then the question is: How far do you defer it? Because if you only defer until the end of the two months, all you’re doing is making the problem worse because in two months they still won’t have enough money to pay the rent. And now they’ve got three months of rent to pay instead of one.

So a careful tenant will try to get the rent abated completely so they don’t have to pay it at all. Sometimes they get that. Other times, they try to negotiate a slower schedule to pay it back. Maybe, starting in January of next year, they pay back the deferred rent in 12 equal installments. That’s an example of the deals that people are making.

The problem is that when you’re a landlord, especially in New York City, your costs are tremendous. The profit margins on a lot of New York City real estate are pretty thin. You get a dollar in, and you immediately pay around a third of that to the city government in the form of property tax. That’s about twice as high as you’d pay anywhere else in the United States, where it’s usually about 14%. In New York, it’s around 30%, 33%. You’ve got payroll. You’ve got insurance. You’ve got repairs. You’ve got water and sewer bills, and then you’ve also got other expenses. The big one is your mortgage. You borrowed to buy the building. You assumed you would have rent coming in to pay the mortgage. And the lenders are going to try to take the same position with the landlords that the landlords take with the tenants—namely, these dollars have to be paid, period.

But forbearances are also happening at the lender level as well. The problem there is many lenders are also borrowers. You think the lender is just collecting money because they loaned money, and if they don’t get their interest for a couple of months they’ll be OK? Not necessarily. Those loans, the commercial loans on, like, apartment buildings and shopping centers, are financed as well—a lot of them. Maybe they’re pledged to other lenders. Maybe they’re put into packages of loans that are supposed to spew out monthly payments to the people who hold bonds. In either of those cases, there’s nobody just sitting on pots of money. It’s borrowed. It’s based on the assumption that there’s streams of cash: One person gets one stream of cash and they pay another stream of cash. All that is being interrupted.

If I were the policy maker here, I’d say to myself: OK, the whole United States economy is on hold. We’re going to have three or four months of nothing. Well, I’m going to figure out a way that all of us, the whole country, can basically just hold our breath for four months. The cost of doing that shouldn’t land on anybody in particular. It was an act of God. Nobody’s at fault. Let’s, as a nation, suck it up. Let’s live those four months, and somehow finance it with some government bond that won’t be paid for 50 years. That’s what I’d try to figure out how to do.

All these big aid programs from the federal government are sort of an attempt to do that. The feds are flying helicopters all over the United States, dumping money, and hoping that, overall, they’re helping everybody who’s stuck in this temporary abyss. Politicians are also tempted to pass laws to protect people, and there’s a lot more tenants than landlords, so the politicians swoop in and protect tenants. They can come in and say, “Let’s do a moratorium on rent. Now we’re going to do a moratorium on single family foreclosures. And we’ll do a moratorium on enforcement of guarantees.” Except there is something called the Constitution, and one of the clauses in the Constitution says you’re not supposed to impair the obligations of contracts. So what they’re doing with leases and guarantees and loans is basically unconstitutional.

Do you have examples about what’s going on with your clients? 

We have a big tenant that, when the whole thing started, had us send notices to all the landlords saying, “Oops, we’re not going to be paying our rent.” Some of the landlords worked with us, some didn’t. Some sent notices of default, some drew letters of credit. It’s all over the place.

On the other hand, we also have landlords who don’t know what to do. They’ve got this one great asset, a piece of New York real estate, and they depend on the money coming out of this one great asset to live, and if the tenant doesn't pay the rent then this creates an immediate financial disaster for the landlord … that’s not the image that you see in the press.

What’s the number one question you’re getting?

The number one question is, “I’m a tenant. I can’t pay my rent. Can I avoid paying my rent?” Sometimes if you look at the lease documents, there are ways you can get out of a lease or at least suspend your rent. We have one where …  it just says if the landlord gives a notice of default then the lease just terminates and that’s the end of that. So our tenant client is saying, “Thank you for your notice of default, our lease terminated, so we have no more liability, because there’s nothing in the lease that says we have any liability.” We will see how that one plays out. Usually you end up agreeing to something and living to fight another day.

Sometimes a store lease will say, “Tenant will always have the right to enter the property through door number three and door number seven.” If the government comes in to say that nobody can go through door number three or door number seven, then the tenant might have a decent argument that they’ve been denied the access that they were supposed to get under their lease. In shopping center leases, there’s often something called co-tenancy where if certain stores go dark, then after a time you’re allowed to go dark, or reduce your rent, or do other things. Those are sometimes helpful.

Was there a moment for you, personally, where you realized how big this was going to be?

Yes. I tend to be an optimist, and I tend to not worry about things. Now maybe that’s the wrong mindset for being a lawyer, but it’s true.

I remember on March 16th, which was a Monday, my staff said they weren’t comfortable coming into the office. First, there was the order to reduce staffing by 50%. Then there was the shelter-in-place order. And then I read in the paper that people who had country houses were leaving town. I said, “Wait a minute. I have a country house. I should leave town.” And that’s what I did.

On March 17th, St. Patrick’s Day, I went to the office, packed up some stuff, went to my apartment, loaded up my car with everything I could put in it, and a friend and I got in the car and drove to my summer house. It felt like I was fleeing something very bad that was going to happen.

I didn’t know how bad this thing was going to be. I had no idea what to expect. Then I gradually calmed down, and here we are three months later. Where I am everything seems pretty reasonable and ordinary, and I’ve been able to do my work. I haven’t been super busy, but I’ve been busy enough.

Less busy than normal?

Definitely. I laid off two administrative assistants, and I have a couple of full-time lawyers who I converted to hourly. But we have work. We’ve gotten some meaningful new assignments during this time, regular work, nothing to do with Covid lease amendments.

Are you back in the office?

I’m still at my house in the country. I’ve been doing a lot of Zoom conference calls and telephone conference calls. I’ve gone into the office a couple of times just to check up on things. But it’s very weird in the city. You’re there in rush hour but nobody’s there. It’s really strange. It’s like Sunday morning.

And you’re in Midtown?

Madison Avenue and 52nd Street.

There’s a concern that after all this is over, a lot of businesses will realize they don’t need the commercial real estate overhead.

That’s absolutely correct. And I’m one of them. I’ve found that I’m able to service all my client work over the phone, with Zoom conferences, with screen shares, with email. And I’m trying to decide whether I should renew my lease once it expires. I don’t really know. I do think people are realizing that remote work is quite effective. The technology has become pretty amazing if you think about it. We couldn’t have done any of this without high-speed Internet service.

The problem is going to be that once everybody gets back to work, people will expect that you will have meetings and closings sometimes. What makes it easy now is nobody expects any of those. Not at all. So the fact that I can’t meet somebody at, say, 50th and Park, is not a problem. But once people start doing that again, if I’m here in the country enjoying the birdies and the trees and somebody wants to have a meeting at 50th and Park, that’s sort of difficult.

Maybe I’ll figure out I do need to have some presence in the city. Do I still need to have a regular office with everybody sitting there every day? I don’t know. But I do like having everybody sitting in the office every day. I miss it.

If more businesses do cut their overhead this way, what would this do to commercial real estate in Manhattan?

It’s going to hurt it. Retail, there’s going to be a lot of vacancies, and those vacancies are going to have to get filled, and the rents are going to go down—which is good in the sense that it makes it easy for weird and quirky stores to open and survive. New York City used to be full of weird and quirky stores: a violin repair person, a book binder, somebody who specializes in old classical records. You don’t have those people any more because the rents are too high. So maybe, with lots of vacant space, the rents will drop to a point where you can have those quirky stores again. I don’t know.

The retail space will have to become filled with stores. It just has to. That’s the dynamic. Space can stay vacant only for so long. In the office market, there will be some reduction in people wanting to be in offices, that’s almost certainly true. On the other hand, assuming the social distancing thing continues, the people in offices won’t be able to be as dense as they historically were. You won’t be able to pack as many people in. So maybe 50% of people who used offices will stop using offices, but those who stay will take up 100% more space than they used to. And you will be back where you were.

Until there’s a vaccine.

Until there’s a vaccine. And my guess is there will be a vaccine, and in a few months we will forget what social distancing is. And that will be just fine with me.

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