Question: “What is a landlord with a troubled CMBS loan?”
Back in the day, a landlord may have had a loan with a life insurance company in Iowa or a pension fund in California that retained the loan through maturity.
Then smart money came along and structured a secondary market for the trading of commercial mortgage backed securities (CMBS).
Now, mortgage bankers could transfer loans to a tax-advantaged trust. The trustee, with promissory notes in hand and an expectation of receiving regular interest payments on the pool of loans, could issue a series of bonds varying in yield and risk. Rating agencies could come in and assign ratings to the various bond classes: from the most secure AAA down through the below-investment grade and unrated bonds. Bankers could underwrite and sell the securities to investors. Bond investors could select from the tranche matching their credit risk, yield, and term preferences. Meanwhile, down in the boiler-room, a master servicer, engaged by the trustee to service the loans, would collect mortgage payments, release disbursements from escrow, and handle other routine loan matters, all so long as a loan performs as expected.
However, a wheel or two came off the truck during the last few years and some loans have not performed as expected.
And rating agencies expect more troubled CMBS loans to surface, despite the gradual improvement in the economy.
Taking advantage of the depressed office market, as a savvy tenant you just renegotiated your office lease reducing your rent and locking in a low rent structure for the next several years. But did you close a big loop hole that could negate this great deal? If your lease is like most leases, it contains a subordination clause making your lease inferior in position to any existing or future lenders. In many states where a lease is subordinate to a mortgage and the lender forecloses on the property, the tenant is at the lender’s mercy as the lender can elect to terminate or recognize the lease. In such an event, the subordinate tenant is in a very vulnerable position as the lender has leverage to force the tenant to renegotiate the lease on the lender’s terms. To plug this loophole, a tenant should have a Nondisturbance provision in its lease and have a Nondisturbance Agreement with the existing and future lender(s). In today’s market, tenants are well advised to preserve some negotiating capital for this important issue.
The December 13, 2010 Wall Street Journal has an interesting article entitled “Downtowns Get a Fresh Lease: Suburbs Lose Office Workers to Business Districts, Reversing a Post-War Trend” by Anton Troianovski. The article summarizes a trend that we have seen across the country in office markets over the past few years where downtown markets have drawn more tenants than the suburban markets. This is largely due to a difference in tenant demographics between suburban and downtown markets in today’s economy. Specifically, many suburban office tenants are directly or indirectly involved with the housing industry where we have seen the largest job losses. Whereas downtown tenants are government entities, banks, financial services companies, law firms and professional service companies. This trend is also being driven by the redevelopment of many downtown areas around the country.
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.
Responding to the need for greater transparency in financial markets in the post-Enron era, a new accounting standard is being presented requiring tenants (both public and private companies) to recognize the current and future value of all leases on their balance sheets. This standard is jointly presented by FASB (Financial Accounting Standards Board) and IASB (International Accounting Standard Board). The proposed standard, if enacted, will be a factor in the real estate decision-making process for all companies. It will have a major impact on financial statements of companies with large lease obligations which are currently considered “Operating Leases”. While this proposed standard applies well beyond the lease of real property, my focus is on its impact to tenants in office leasing. It has been reported that this change will result in between $1 and $2 Trillion being transferred to companies’ Balance Sheets. Some question the timing of this proposed change given the economic conditions and the state of the commercial real estate industry.
All forward thinking tenants should review with their real estate advisor how the proposed standard will impact their real estate strategy. Below is a summary of the current accounting standard, the proposed new standard and its impact on office tenants.