Failing lease with personal guarantee

[Ash Patel]

One year ago, I purchased a property for $550k and signed a tenant to a 10 year lease.  The proprietor was a coffee shop/bookstore that was operating down the street.  They wanted to expand as well as offer food and alcohol.  In addition to the $550k purchase, I paid $62k in TI, offered six months of no rent then six months of half rent.  Just as we start full rent, I am finding out that the business is bleeding cash.  The husband and wife both have assets and they both signed a personal guarantee for the full 10 year lease.  These two individuals went from selling coffee and books in a small footprint to now operating a bar/restaurant/bookstore in a large space.  They are not experienced restaurateurs but are mature and intelligent individuals.  The wife runs the business and the husband helps out but has kept his job as a high level analyst for a large multi-national bank.

They have called a meeting to discuss their situation. I will not offer any more concessions and my advice will be to get an experience consultant to help them.  Does anyone have experience in enforcing a personal guarantee on a commercial lease default?  My goal would be if they default, to come up with a settlement and release them from the lease, but if we cannot agree on terms, I am concerned with what the outcome of legal proceedings would be.  Another scenario would be that they sublease the building but retain the guarantee.  Not asking for legal advice, but would like to hear if you have experienced this.  THANK YOU!!

[Joel Owens]

Yes my clients have done these workouts before with tenants.

The REAL question that has nothing to do with the personal guarantee is the business in demand in the area? If it is are there multiple similar businesses for over saturation where constant specials are needed to gain business and work on razor thin profit margins that have to be made up on volume? How is access and parking in and out of the property? How are the sightlines from the street (flat, raised, in a hole view)? Is the property on going home side or going to work side?

This could be a business management issue, marketing issue, location issue, sightlines issue, saturation issue, high labor market for the business type, etc. All of these factors or more could contribute to problems with the business.

A mom and pop tenant like that I would have never offered the structure you did with them but it's water now under the bridge. Even mom and pop you have to weigh if they are a single unit or a multi unit operator that has been proven over time. Lot's of these businesses are owner operators and they burn out real quick. Margins in food are about 9 to 10% net after expenses so 500,000 sales you are looking at 45,000 to 50,000.

The people that make any money tend to scale and own 30,40,50 or more of them where they can add in layers of management and no longer be the owner operators but still make good cash of 9 to 10%. Even with that if food costs go up, labor goes up, re-imaging inside and out, etc. can really put businesses in trouble. The great operators put money aside to constantly update their spaces to keep consumers coming in and sales and profit up. The ones that are a majority keep the high cash flow and spend it and the business gets run down over so much time and customers drop off and the business owner does not have the money to re-update the business and turn it around.

The personal guarantee you can have liquid and non-liquid assets and assets that are easily attachable and assets that are mostly protected like retirement accounts. Litigation can get expensive and time consuming. If their business can't be turned around in the foreseeable future  then the writing might be on the wall and time to negotiate a termination and release of liability for a fee. If the blip is temporary with business you might could offer a short term solution of reduced base rent and sharing of profit above sales of XX annually. This way they get temporary relief but do not get cherry reduced rent for years on end while the business recovers and makes tons of money and you get nothing for it.

Generally in a settlement you are trying to get enough money to cover TI's, lost down time rent, LC's, attorney fees to put new tenant in where you are not coming out of pocket. Basically hoping for break even. Another option is they could possibly sell part or all of the business to a stronger operator.

Being in the food business for decades myself before getting into commercial RE it sounds like to me the wife likes running the business and the husband does it on the side while most of his focus is on his job that pays the bills. If they weren't paying you rent before could not get profitable then it looks bleak for turning it around. A turn around specialist could be brought in but then paying more money they do not have.

No legal advice given.