Feature Article - The Ever-Changing Market

Today’s current economic conditions are having a profound effect on the commercial real estate market. Both tenants and landlords have been impacted, and you should be aware of the possible consequences for your business. As corporations have moved into the third calendar year of the economic recession, the latent influence is finally being felt by most buildings. Since lease terms are typically three to five years, many well-leased properties can “ride out” a typical downturn of 18 months, but this one is different. Tenants, as their leases roll, are demanding lower rents to be market competitive and the net operating incomes of buildings have fallen. To make matters worse, the capital markets have significantly constricted, reducing the traditional outlets for owners to fund mortgages and working capital. This confluence of lower rents and tighter capital means many buildings will suffer bankruptcies, foreclosures, and operational deficiencies.

The greatest likelihood of tenants being impacted is through their building undergoing bankruptcy or foreclosure. In this instance, they will become subject to the attornment of their lease to the lender. In most cases, lenders want tenants to stay and continue to pay rent, but without a non-disturbance agreement in place, in some cases, tenants' leases can be nullified, forcing them to find new space. Existing tenants should review their lease with an attorney or real estate professional to make sure they are protected in case of the landlord’s default.

As owners' cash flow diminishes, they will be forced to start cutting costs, which will result in a lower level of services to tenants. Landscaping maintenance will be every other week, janitorial will be provided less often, and repairs to HVAC and electrical systems will be delayed. Common areas like hallways and restrooms will not be refurbished as needed or at times delayed until cash flow improves. If the building you are in goes into foreclosure, then it is very likely to expect to see all of these items occur as the owner resorts to spending nothing on the building and the lender does not yet have possession of the asset.

Tenants that are looking for space should take extra time and review with their representative the fiscal viability of each landlord they are considering. The cost basis and debt on the property should be considered, as well as the size and operating history of the landlord. However, do not let the size of the company be your only indicator, because many big real estate companies have let individual partnerships go back to the lender.

Lastly, ask about the building's cash position. Recently, we saw a large real estate company that owned their project free and clear, but did not have near the operating capital to pay for build-out and commissions. This is a very unusual situation. This very cash flow problem caused a significant and dangerous delay in the landlord’s execution and nearly forfeited the transaction. Historically speaking, this would not have happened and simply demonstrates what unusual times we are living in these days.