It would be a nice world if everyone did the right thing at the right time, for retail tenants that means paying their rent on the 1st of every month, like clockwork. Unfortunately we do not live in such a perfect world and you may come across a tenant that has poor cash flow and believes it’s OK to use you as his bank and is regularly late in paying the rent.
One of the key reasons we selected retail shops as our Engine of Wealth is due to the reliance the tenants have on their premises. You see the retail shop is the tenant’s livelihood, it’s their job and you as the landlord have the right to take that shop from them if they breach their lease. So the stakes are high if they do not remedy their arrears when formally asked.
Over the years I have built up a level of experience in the way I approach rent arrears. In the early days I would accept that the tenant was just experiencing a quiet period such as a cold winter month where less people go shopping, as soon as it warms up everyone will come out again and the tenant will return to profitability and pay his rent arrears. In fact I was probably to obliging letting tenants use me as their bank to smooth their cash flows, you see I thought and to a certain extent still do today that a landlord and a tenant have a symbiotic relationship. If the landlord helps the tenant then in return the tenant help’s the landlord by paying his rent.
Unfortunately all I ended up doing was encouraging poor rental payment hygiene, I had tenants that started paying their rent at the end of the month instead of the start of the month, then they would miss a month and suddenly I was owed close to two months in rent. It’s always amazing how people that owe money suddenly become so busy they have no time to return your calls or send you an email as to why they haven’t paid their rent and more importantly when they will be paying the rent. In the end I found that if you allow tenants to pay the rent when they feel like it and don’t enforce the conditions of the lease (ie. Rent to be paid on the 1st of each month) then you encourage more of this poor behaviour. As the expression goes “if you give them an inch they will take a mile”. It becomes a slippery slope where the tenant assumes you won’t mind if they don’t pay their rent this month.
After several bad experiences with tenants not paying their rent on time I began to limit my exposure to bad tenants behaviour by strictly enforcing the lease conditions. Now when a tenant doesn’t pay their rent I call them (or email them if you prefer) and let them know I am not a bank, I have a mortgage to pay and need them to deposit their rent immediately. I remind them that if they are experiencing cash flow difficulties they should go and see the bank about a credit card or an overdraft facility. If they don’t want to use a bank that’s fine, I ask them to call their father, mother, brother, sister, cousins or friends and ask them for a loan as it is not acceptable to not pay the rent.
What I find is that after this conversation most tenants will pay their rent arrears within one or two weeks or will ask me to agree to a payment plan that will see their arrears cleared after one or two months. In situations where the tenant still fails to comply and clear their arrears I ring them with a firmer approach. I inform them that I have given them long enough to clear their arrears and don’t think it’s fair that they are treating me as their bank. Now in most leases rent arrears attracts a penalty interest rate typically 2% above the current available bank rates, I let the tenant know I will be applying this interest penalty to their arrears as per the lease and ensure I do that.
If it gets to the next step you need to become formal and legal. I inform them in writing that after 14 days if their arrears is not cleared I will commence legal action. If the arrears are not remedied, I will instruct my lawyer to issue a “Letter of Demand” formally giving the tenant a further 14 days to remedy their breach. Therefore if after a total of 28 days the tenant has not settled their arrears, you have the right to lock the doors. Of course this step is a last resort, I don’t like getting lawyers involved as they will charge $500-$600 to issue the letter and that will be added to the tenant’s arrears. I find that if a tenant pushes you to a legal letter most will get the idea you mean business and pay their arrears if they want to keep their shop.
On one occasion I did issue a letter of demand on one of my tenants, after the formal 14 day warning the tenant had still ignored my requests to pay the rent. It was reassuring that unlike residential tenants who don’t pay I was legally within my rights to go onsite and padlock the door. I placed a sign on the window letting the tenant know they would be in breach of the law and arrested if they attempted to enter the premises. Now you can’t do that in the world of residential investment. The particular shop was a hairdressing salon and I remember locking the doors at 7.30am before the start of the day’s trade. Walking away I wondered if the tenant would return my calls now!
Sure enough at 8.15am I had a frantic call from the tenant pleading with me to let her re-enter the premises. She was extremely stressed as she had back to back appointments all day and two staff that needed to be working. I informed her that she should have paid her rent, she should have returned my calls and you can’t occupy the premises when you haven’t paid your rent. I would have been more than happy to negotiate a payment plan if you had only bothered to call me. By ignoring me you opened yourself up to this eviction and the store will now remain shut until one of two things happens, you pay your arrears in full or I find a new tenant to run the store. I told her that I will be placing an advertisement in the paper today for a new hairdresser and under the terms of the lease she is still liable for the rent until the new hairdresser takes over, and you are also liable for the cost of the advertisement.
When it gets to this stage, here is one of the things that I like about retail shops, the tenant is invested in the property, they own the fitout and in this case the hairdresser had spent over $30,000 on the fitout that along with her customer goodwill is lost upon her eviction. At 9.00am I received a call from her boyfriend saying that he would pay her arrears if I let her re-enter the premises and he would also be prepared to be a guarantor on the lease if I reinstated the lease. I indicated that I hear lots of promises but if he goes to the bank and deposits the money and SMS’ me a copy of the bank transaction receipt I will let her pick up the keys and re-enter the premises. He did that within the hour.
The above example demonstrates just how important paying the rent is to a tenant, when faced with losing their business, their job and their fitout investments most tenants will find a way to pay their arrears. I once had an IGA franchise invest $500,000 in the fitout and sign a 15 year lease. Can you imagine him not paying his rent and risking eviction and the loss of his $500,000 fitout – not likely, he pays his rent like clockwork. Another important point to also keep in mind is that tenants have goodwill accrued in their business, a future buyer will place a value on this goodwill. For a hairdresser the years spent in one location creating good will with repeat customers adds a significant premium to the salon when it comes time to sell the business and retire.
If they are unable to pay because their business is failing, the tenant needs to consider selling their business. It does not remove their obligation to pay the rent, but allows the tenant to continue trading while the business is for sale. This is an ideal outcome, I get a better tenant possibly with a better business accruement who will pay the rent, the tenant gets some cash for their business and pays out any rent arrears, which is better than being evicted and getting nothing.
In my hairdresser example, after she finished her day back in the store she rang me. I asked if she needed to sell the business as it was clearly not making enough profit to pay the rent. She replied “I’ve been using the profits to help my daughter, she got herself into some financial trouble, that’s why I’ve not been paying my rent, I will be able to catch up next month.” I was shocked! She had been intentionally diverting the rent to help her daughter, yet she didn’t ask me for a loan and just hoped I wouldn’t do anything about it. After her admission she paid out her arrears over the following month and has been on time with her rent ever since.