As most professionals in commercial real estate know, debt plays a crucial role in shaping the market and influencing the relationships between landlords and tenants, as well as landlords and lenders. Given this widely accepted dynamic influence, 2024 is shaping up to put some of these relationships and the market to the test.
According to Guggenheim, nearly $1.2 trillion of commercial mortgage loans will mature in 2024-2025, with office loans accounting for 17 percent of those maturities. 75% of these loans are held by local and regional banks, with only 10% of CMBS loans paid off at maturity on original terms from July – September of 2023.
With $15.2 billion of commercial mortgage-backed securities in the office sector expected to mature this year, Moody’s Analytics states that 80% have performance characteristics that would make them difficult to refinance, requiring fresh equity to balance the debt yield on many of their loans to retain building ownership and not turn it over to the lender.
This equity infusion will be critical to lenders, many of whom are facing increased scrutiny from regulators. Last year, regulators unveiled the “Basel III” proposal to overhaul how banks with more than $100 billion in assets calculate the cash they must set aside to absorb potential losses. This means they must reserve more capital for their balance sheets from all their assets, including their commercial real estate holdings.
This comes at a time when many companies are rethinking their office footprint and incorporating hybrid work schedules modeled off the work-from-home culture fostered during the pandemic. This new way of working continues to diminish physical office space’s role in Corporate America’s overall business strategy—complicating a lender’s ability to collect debt while threatening the financial viability of many owners and landlords.
CRE debt provides tenants with a competitive advantage.
A landlord’s debt burden can have direct and indirect effects on tenants, ranging from basic maintenance and amenity concerns to a landlord’s ability to fund tenant improvement allowances and execute on lease negotiations.
Should a building go into default and a bank, the change in landlord can impact the continuity of a tenant’s lease agreement and building services. Landlords with a reputation for sound business practices will try to work with their lenders to address their debt obligation early. In contrast, some others may delay this process to push any cash obligations owed into the future.
As such, tenants should have an idea of when their landlord’s loan matures, as that can serve as an inflection point in future lease negotiations. The closer a landlord is to that maturity date, the fewer financial options they will have, especially in this environment. One of the most impactful ways to ensure a landlord’s ability to maintain an asset and do so with the least out-of-pocket cost is to secure long-term leases with the building’s most prominent tenants. So, 18 to 24 months before loan maturation, tenants should start engaging in renegotiation discussions with their landlord, whether it coincides with their lease expiration or not, as it will directly impact the loan proceeds achievable in a refinance and could be used to negotiate a favorable extension with generous tenant allowance improvements.
Facilitating winning arrangements.
During negotiations, tenants should push landlords to provide transparent disclosure regarding their financial status, including debt obligations, to ensure tenants are fully informed about the potential ownership risks. Tenants should conduct due diligence and seek clarity on the terms of their lease agreements, including any clauses related to the landlord’s debt and its impact on the property. Similarly, lenders who want to recoup their capital will want to ensure their real estate assets have value and are secure with stable tenancy.
Initiating these discussions with landlords and advocating for transparency empowers tenants to safeguard their interests and mitigate risks associated with landlord debt exposure. Similarly, landlords and lenders benefit from open communication with tenants, fostering a mutually beneficial relationship that bolsters property value and stability.
The complexities of landlord debt and its implications on financial flexibility and decision-making underscore the need for tenants to seek guidance from knowledgeable advisors who possess a deep understanding of:
- Ownership structures & portfolio dynamics
- Regional and national capital market trends
- Developments in the debt markets
- The financial health and strength of individual landlords.
Such expertise enables tenants to achieve their goals irrespective of market conditions and often times agnostic of lease expirations. By fostering an environment of transparency and leveraging expertise, tenants can effectively mitigate risks and achieve their objectives, ensuring long-term success in the evolving landscape of commercial real estate.
Shay Pope, MCR serves as a Managing Director and Executive Vice President for Stream Florida, helping a diverse range of industries develop and implement strategic plans that align real estate and human capital strategies with long-term financial goals.
Jason Warren is the Head of Strategy and Analytics for Stream Florida, using finance, analytics, and forensic due diligence to provide clients and brokers with strategies that serve as a foundation for broader real estate decision-making.
John Rogers is an Executive Managing Director & Partner for Stream’s Investment Management team, managing Stream’s discretionary equity funds across investments and assets, along with all debt capital market activities for Stream’s markets nationally.
