Today’s office market presents unprecedented opportunities for tenants. At the same time, tenants face risks that were uncommon a few years ago related to the financial well being of landlords. With some of the biggest names in the industry struggling, savvy tenants are extending their due diligence to the financial strength of their current and prospective landlords. Unlike a real estate sales transaction where the parties go their separate ways after the transaction is finalized, tenants must keep in mind that a lease is a long term business relationship. As this business relationship in most cases is vital to the operation of a tenant’s business, tenants must thoroughly vet their landlords.
2-Prong Inquiry: A tenant’s inquiry into the financial strength of a landlord is two-fold:
(1) Short Term – does your landlord have the financial ability to fund the lease transaction? Are there sufficient funds for tenant improvements, brokerage fees, base building construction, etc…?
(2) Long Term – does your landlord have the wherewithal to maintain the building and meet underlying debt service?
Tenant Strategies: The following are some strategies tenants can employ to vet their landlords. Tenants should keep in mind that almost all buildings are owned by an entity specific to that property and that entity (usually a Limited Liability Company) is affiliated with the Landlord. Landlords have each property individually owned by these special purpose entities for liability reasons. Some landlords, however, will package together a portfolio of properties for financing.
- Building’s Occupancy Level & Tenant Roster – examine the building’s occupancy level and tenant roster. Ask yourself: over the course of my lease, how well occupied will the building be?
- Survey tenants in the Building – have your agent conduct a survey of tenants in the building to gauge their satisfaction level which is in indicator of the landlord’s financial well being.
- Check Online Public Records – most counties have their records online so that you can check the status of the ownership of the building. Here, you will discover any outstanding violations as well as liens including mortgages, etc…
- Title Search – order a title report from one of the national title insurance companies if the online search is not adequate or concerns arise from the online records search.
- RFP – include ownership & financing questions – include in your agent’s Request for Proposal that the Landlord address: full identity of ownership, all debt service and financing relating to the property, tenant lease rollover.
- Landlord Financials – include in your RFP a request for the Landlord’s current and prior 2 years’ operating statements for the property.
- Loan Status – from the RFP request, it is important to analyze the loan on the property. Does the outstanding loan exceed the building’s market value? The type of loan is particularly relevant where the building is “upside down” (loan exceeds value). A loan held by a bank, as opposed to a Commercial Mortgage Backed Security (“CMBS”), is less challenging to restructure. We will address CMBS in a future blog.
- Escrow – before signing a lease, establish an escrow account (through a mutually acceptable independent institution) which Landlord will fund for payment of all transaction costs.
- Maintain Reserves – include in the lease that the landlord maintain reserves each year to cover debt service, building maintenance, insurance, etc… Note, most lenders will have such a reserve requirement already in place.
- Non-disturbance Agreement – to preserve your tenancy and lease in the event the lender assumes ownership by foreclosure or otherwise, tenants should insist upon a Nondisturbance Agreement from the lender(s) and landlord. While we will address this concept further in a future blog, a Nondisturbance Agreement is a 3-party agreement among lender, landlord and tenant assuring the tenant that the lease will not be disturbed (assuming the tenant is not in default) should the lender assume ownership.
- Self Help Rights – as a last resort, where the landlord is not performing and as a more practical measure than litigation, a tenant should have a self help right in the lease. Under such a right, after the landlord fails to perform certain obligations under the lease, the tenant steps-in and cures the landlord default (e.g., failure to fund construction allowance) and offsets those costs against rent. As you can imagine, landlords and lenders are very reluctant to grant such a right to tenants. Tenants employing the right negotiating strategy can be successful at times in obtaining such a self-help provision.