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Posted by John Pagliassotti on Monday, September 19, 2011

How Commercial Landlords Should Balance Rent Payments, Late Fees and Grace Periods

SAN FRANCISCO – August 29, 2011 -- Landlords are in the real estate business for one primary reason: collecting rent. Almost all aspects of property ownership and management revolve around rent collection. John Pagliassotti, AIR Commercial Forms author and expert, and forensic real estate consultant with Opine Experts, offers the following suggestions to landlords and asset managers to better influence rent collection rates and long term property success.

Landlords must be firm in their negotiation of leases and the use of the late payment fee provision in order to provide an uninterrupted income stream and positive cash flow for their properties. The following tips are useful reminders for any new or seasoned landlord.

• Clearly define the late payment fee in the lease agreement. The late payment fee is one of the most negotiated of all lease provisions and the first line of defense against nonpayment of rent. For most properties, the late payment fee is usually a percentage of the rent and paid to the landlord if the rent is not paid by the due date.

• Be very clear regarding the date in which rent is due and the consequences for not adhering to that date. Lease agreements should include a clause that not only allows for a grace period, but clearly defines the time frame and consequences for not following it. For example, the rent is due on the first and the late fee is triggered on the fifth.
o Tenants mistakenly believe that the grace period serves as a de facto extension to the date on which the rent is due.
o Tenants who pay the rent after the first are at risk of defaulting on their lease.

• Understand that tenants are hesitant to agree to the terms of a late fee clause; take steps to address it early in the process.
o This five-day grace period, for example, is a muddy area for both tenants and landlords; it’s imperative that a discussion ensues at the onset of lease negotiation to clearly define what that time frame implies.

• Determine as a landlord what is acceptable for tardy rent payments. o There may be a number of legitimate reasons a tenant delays delivering a rent check. Delays can be caused by checks getting lost in the mail, accounts payable systems failing, or general check processing errors. o As a landlord, what are you comfortable with – allowing one or two tardy payments or none? Assess the risk of the tenant – if they’ve paid on time 12 months in a row, and they communicate in advance they may be late on the 13th rent, you may allow one tardy payment without penalty. This should be a case by case situation.

• Tenants often try to negotiate a reduction in the amount of the late payment fee, or eliminate it entirely.
o One compromise with proven success is an agreement to waive the late fee once per year over the term of the lease. This allows for unpredictable errors without penalty, while ensuring that the landlord maintains the leverage of a reasonable late payment fee over 90% of the lease period.

• Avoid impacting the monthly debt service on the property by “floating” the tenant.
o In most cases, at least part of the rent payment is used for monthly debt service which carries a late payment penalty of its own.
o A prudent landlord understands this and the value of the late payment fee provision as a tool to protect their investment.

• Avoid reducing the late payment fee below what is effective in order to maintain positive rent collection. o If the late payment fee is reduced too low, late rent payments can effectively become a low interest loan to the tenant.
o Avoid this scenario by holding firm to a percentage that both deters a late payment and encourages prompt payment.

John Pagliassotti is a commercial real estate consultant, author and educator with more than 25 years experience in all aspects of commercial real estate brokerage, property and asset management, and expert witness services in Orange County, Calif. , has joined its firm as a forensic specialist.

He is author of “AIR Commercial Real Estate Forms: A User’s Manual Volume I – Lease Forms and Addenda and an expert in international asset management and lease negotiations. He is a member of IREM, AIR and NAIOP.

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