If you thought the office environment couldn’t get any more tenant-favored, recent landlord defaults are now putting their financials in the hot seat when it comes to discussions with new prospective tenants.
In the aftermath of several bank collapses with 190 rumored other possibly on the horizon, commercial loans have seized up like an engine without oil. Commercial properties are largely becoming liabilities due to stalled occupancy rates, high interest rates, and about a million other circumstances stacking up against them.
All this leads up to the fact that your current or prospective landlord may be in trouble. Let’s get into what you can do to protect yourself.
Commercial Landlords are Suffering
Commercial real estate property owners are struggling with record-high vacancy rates to say the least. Hybrid work, pressure building in terms of economic uncertainty, and rampant layoffs have irreparably stunted demand for office space.
According to Costar “Declining office usage has meant the U.S. is projected to end the decade with a record 1.1 billion square feet of vacant space, compared with 688 million square feet in 2019....
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About 330 million square feet of U.S. office space could become obsolete on that same timeline if working from home remains popular.” -Costar |
Commercial landlords and their profit margins are suffering as they have been forced to become more competitive to attract long-term tenants. Because, even if they manage to secure a reliable tenant with a good credit history, they may need to offer a large tenant improvement allowance and/or a lower base rent to entice them to sign a lease.
Brookfield Corp, parent of the largest office landlord in downtown Los Angeles, with a portfolio totaling $2.28 billion in secured debt, is defaulting on loans.
This has resulted in a challenging business environment that has caused some property owners to take on more debt than they can handle. In an unprecedented situation, some major real estate holders are now defaulting on their loans, and investors are exploring more viable investment opportunities.
In short? Good luck getting a loan for commercial real estate right now.
“Borrowers can expect increasing difficulty in the coming weeks and months obtaining new commercial real estate financing, extending or refinancing existing real estate financing, and accessing financing draws for ongoing construction projects,” according to GlobeST.
As a result, commercial tenants should be prepared for the very real possibility that their landlord may be in for trouble. In fact, the odds may be as much as a one in third chance that your landlord’s risk is too much to bear.
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About 30% of U.S. office buildings, which is translated to a collective estimate of $1.1 trillion are at high risk of becoming obsolete. -According to data from research analyst for Goldman Sachs, Randall Zisler |
And this changes your course when looking for a new property. Now, instead of prioritizing location or amenities, tenants have more foundational concerns like can a certain landlord stay the course for my lease? And are hard times on them going to negatively impact the service and upkeep of my building?
Beyond contemporary concerns, there are innumerable other factors to be prepared with when looking for a new office. We cover ways to find the best office space, for the best price, in our free course below!
Tenants Turning the Tables
According to Costar, “Turmoil in the U.S. office market — which has triggered missed loan payments and foreclosure warnings — has meant prospective tenants are now taking a closer look at the financial health of property owners.”
Because, intertwining yourself in a lease with a landlord who can't pay their bills is a fate that no commercial tenant wants to suffer. As a tenant, your finances will undoubtably be at play. This especially seems to be the case with tenant improvement allowances. If it turns out your landlord can no longer reimburse your renovation costs or fails to make promised improvements, you don’t want to be on the hook. As a result, tenants are being advised to put TI allowances into an escrow account.
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“Some tenants, he said, aren't negotiating with building owners until they are satisfied they understand a property's financial situation.” -Costar |
Of course, this is powerful bargaining power for a tenant. In the past, the spotlight was cast on the credit-history and financials of prospective tenants. Many aren’t shy to cast irony on this shift, noting that the “tables have turned.”
What Year is it Anyway?
Tenants have an innate ability to pit their tenancy against the market to receive favorable prices right now. And of course, this bargaining power is powerful, but how will it play out when every commercial tenant takes advantage? How about we direct you to the next quote…
“In many ways it is a great time to be a tenant. Rents have dropped by 15 percent or so in Manhattan, smaller security deposits are required, and some landlords are offering free rent for as long as a year and a half.”
Now here’s the kicker. That’s not a quote from this year. It’s from 2009. Yes, that’s right, 2009, like the year after the 2008 crash and fallout. So, if you were getting déjà vu before, your instincts were dead on. The high interest rates and investor withdrawal rates are reminiscent of the past crisis.
The parallels are obvious, especially considering that the title of the article from the quote was entitled “Commercial Renters Have a New Worry: A Landlord’s Default.” Yikes, doesn’t this still ring eerily familiar.
Lessons From the Past Tenants Can Use Today
So, we’d be foolish not to look to our history for possible escape hatches. The suggestions that protected some tenants then are essentially the same as the advisements now:
- Tenants can demand that landlords offer TIA funds in an escrow or credit letter, avoiding their seizing in a possible bankruptcy.
- If you’re signing a new lease, ensure that you receive a Non-Disturbance Agreement (NDA) among yourself, the landlord, and the landlord's lender, which guarantees the your right as a tenant to the leased premises in case of landlord default or foreclosure. The NDA allows the tenant to keep occupying the property according to the existing lease terms, even if the landlord loses ownership. It is also possible to obtain a subordination, non-disturbance, and attornment agreement (SNDA), which provides additional protection, but it is important to consult with a lawyer to ensure that the SNDA clause is properly worded.
- If you’re looking for new space, direct your attention to landlords that you know can weather the storm.
At the end of the day, new tenants are being guided to landlords with stronger financial backings. This requires doing your due diligence, conducting research on their stability, and acting on it.
Right now, this is being recognized as a “flight to quality,” which again mirrors what went down in 2009. The divide between premium office buildings and those that aren’t is set to widen drastically. This will likely in turn feed a negative loop of property devaluation and defaults of landlords from non-major firms.
But, if your landlord’s financials do start to negatively implicate your tenancy, you are not entirely left up the stream without a paddle. Back in 2009 Marisa Manley, president of Commercial Tenant Real Estate Representation, explained that…
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“If the landlord doesn’t perform certain duties, you have the right to go and hire someone to do them yourself,” she said, and get compensated by the landlord. “These are things like cleaning, and heating, ventilation and air-conditioning maintenance.” Marisa Manley, 2009 |
This could be a tangible method to remain upkeep of your space while ensuring you don’t go too deep in the hole for what your landlord should cover.
How Tenants Can Protect Themselves
The truth is that no one can fully predict how this will play out. We are in the midst of an unprecedented time. While 2008 entering 2009 represented an outright crisis, every issue they experienced then is compounded now by hybrid and remote work.
But it is because of this influence that tenants can drive even harder deals. If you know what you look for in a property, landlord, and lease, you can stay afloat throughout this crisis in premium, yet affordable office space.
But there’s quite a lot of landmines to look out for now. Especially, when it comes to your current or prospective landlord. That’s why nothing should be left to chance and an unbiased Tenant Representative is an especially valuable ally. Don't expect your landlord's rep to tell you these things.
By working with a True Tenant Rep™, tenants can navigate the complex market and ensure they make informed decisions based on their individual needs and priorities. Tenant Representatives can help tenants identify properties and landlords with strong financial backing, negotiate favorable lease terms, and navigate the complexities of lease renewals and potential landlord defaults. They can also help tenants avoid common pitfalls and ensure that they are getting the best possible deal for their business.
In a market where landlords are increasingly struggling to maintain occupancy rates and meet their financial obligations, commercial tenants need to be vigilant and proactive in protecting their interests. A True Tenant Rep™ at iOptimize Realty® can provide the necessary guidance and support to help tenants achieve their goals and secure their future despite unprecedented market conditions.
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