Archive for July, 2010

What You Don’t Know Can Hurt You

Many business decision-makers staying abreast of current market trends are in the process of negotiating lease restructures. This approach is now commonplace.  The end result is often in the form of increased savings.  Nonetheless, to protect your company and avoid risky and costly errors, it is crucial to understand the financial position of your landlord, and how your company might affect that position.  When considering a lease restructure or any such significant commitment, acquiring this understanding is a very important part of your decision making process. .

Future Real Estate Market

In an already unstable market, several factors are pointing to a continuation of struggles and hampered growth. Continued reductions in cash flow, investors shying from commercial real estate, continued unemployment and strong uncertainty for a forthcoming economic recovery, has forced commercial property owners to absorb more and more empty space.   Just as all real estate, commercial property values has also taken a big hit in the last 12 to 24 months.  Unless there is substantial job growth encouraging absorption of empty commercial space, the market may continue to suffer.

Current Trends

Careful landlords have refinanced real estate debt thus reducing monthly debt service costs. The rewards of refinancing are twofold: 1) protecting themselves against future financial downside events and 2) to increase current profits. Although many say the economy is beginning to show signs of gains, commercial real estate, being a lagging indicator of economic change, has not yet seen a marked increase.  The essentials of real estate recovery are a substantial increase in demand and substantial absorption of available space for lease, neither of which seems to be happening.

Meanwhile, the delinquency rate of commercial mortgages continues to rise. “Commercial mortgage-backed securities (CMBS) originating in 2005 drove an increase in delinquencies to 6.29% at the end of February, according to the Fitch Ratings delinquency index of 2,505 loans totaling $28.5bn. Behind the overall increase were office properties, which grew 45bps to 3.5% delinquent.”

According to Real Capital Analytics, Inc. in a report in February, 2010, the default rate for loans on office, retail, hotel, and industrial rose to 3.8 percent up from 1.6 percent a year earlier. A prediction of a 5.4 percent by year end seems a good potential.

Should Corporate Tenants Care?

When a corporate tenant restructures its lease based on better business or financial terms, must the landlord honor the terms? Many are surprised to find the answer is maybe! Precise terms contained in the lease documents will dictate which portions of the lease agreement are honored.

Occupying space in a building where a landlord defaults and then loses the building can place tenants in a precarious position.   Things such as dealing with transitions between owners, trustees, and others can place tenants in an uncertain position for extended time periods.

Unless a precise and well-constructed “non-disturbance agreement” was a component to the lease restructure, the new landlord might not have an obligation to honor the tenant’s lease. Termination is a possibility.  Obviously this causes difficult operating scenarios, forcing management to concentrate on the unexpected issue.  Employee productivity, operations, and corporate profitability are all at risk under such conditions.

What You CAN Do

There are things you can do to protect your company from such stressful issues. Make sure you know who you’re doing business with. What has your landlord been doing over the last couple of years? Answers to the following questions will give you the knowledge you need to make an informed decision regarding lease restructures.

• Has the landlord restructured leases and retained tenants in his portfolio, including your building?

• Have tenants relocated from your building, significantly reduced space, or gone out of business?

• Has the occupancy levels of your building been affected by those events?
• Is your building going to experience large amounts of simultaneous lease expirations that could negatively affect the financial strength of your landlord?

• Has the level of service or landlord / property management responsiveness dropped?

• Does it appear that the landlord may be cutting back to reduce operating costs?

• How does what your landlord has accomplished compare to what’s going on in the local market?

Don’t just review statistics and the numbers.  Instead collect and review data in a manner that will provide a valuable understanding of your landlord’s position.  Consider carefully how issues could come into play and how you can make more intelligent decisions to protect your company from potential harm.

Even with a good understanding of your landlord’s current status, it may still be difficult to understand financial implications your company’s transactions can have on your landlord.

When you’re considering a lease restructure, consult your real estate advisor for guidance to help you achieve terms creating flexibility along with greater profitability for your company…all without placing unnecessary burden on your landlord. Helping to keep your landlord in business can yield positive benefits for your company.