In today’s rapidly changing economy, it’s not always apparent which assets are distressed until it’s too late, putting tenants looking to renew space or transition into a new building at risk. This change in the market, resulting from recent bank failures and $1.4 trillion in CRE loans coming due, has caused many landlords to stop funding transactions to keep tenants in their buildings and proactively give their buildings back to their lenders. This dynamic has left tenants in a difficult situation where they cannot stay in their current space even if they want to, shifting the trend from a “Flight to Quality” to a “Flight to Capital.”
An increase in debt maturities isn’t necessarily problematic; however, the combination of rising interest rates and office value decline is. As of February 2023, U.S. commercial real estate debt rose to a 14-year high of 5.2%, with defaults at the highest they’ve been since 2009. Office properties accounted for 44% of all defaulted commercial mortgage-backed security debt transfers, followed by retail at 32% and multifamily at 19%.
While it’s been standard practice for a landlord to request an occupier’s credentials to ensure their ability to pay, conditions within the market have caused the tables to turn. Occupiers, in need of additional assurances as the economy continues to evolve, are now requesting full disclosure of a landlord’s financials before signing a lease, all to ensure the asset remains in prime condition and well-managed during their tenure.
Tenants must understand the creditworthiness of a landlord before signing any deal to ensure their own company, finances, and operations are not at risk.
As occupiers look to renew or move into a new space over the next several years, it is crucial to understand if the landlord can retain the asset and has access to the capital necessary to fund operations that fit their tenants’ needs.
If the landlord cannot retain the asset during tenancy, it’s likely that the building will have a different owner, whether that be a bank, special servicer, or a new landlord through a sale. It’s important to note that many banks and special servicers do not have the infrastructure to manage the portfolio of buildings that will return to them during this debt crisis, leaving a tenant with many unknowns should the landlord cease to own the property.
And, since numerous banks and private debt funds have tightened their lending policies or stopped lending altogether, many landlords are putting forth proposals that their lenders deny, meaning they cannot fulfill promises made. As such, stable assets, rather than just updated or new, are becoming top-of-mind for many occupiers as they look to ensure their operations aren’t negatively impacted by an asset’s default.
It comes down to due diligence.
Determining whether a landlord can retain an asset as well as if a landlord has the capital needed to fund a new tenant transaction comes down to evaluating the landlord’s:
- Current cash position
- Debt and equity structure
- Ability to raise funds
Additionally, tenants should be aware of their potential landlord’s investment strategy to ensure they can commit to numerous deals simultaneously, whether they are looking to sell and reallocate funds to a different asset class or conduct a portfolio rollover.
By diving into a landlord’s capital stack to understand their investment strategy and sources of financing, occupiers can negotiate from a position of strength, regardless of market conditions, and confidently move into the perfect office location for the entirety of their tenancy.
How well do you know your owner?
As markets evolve, remaining informed and strategic is integral to driving value and growth. Stream’s extensive “Know Your Owner” assessment provides clients with a comprehensive understanding of a landlord’s financial position and/or the underwriting of landlords in potential relocation options so that they can move forward with certainty. With unsurpassed market knowledge and data-led creativity, Stream’s advisory services are crafted to ensure clients achieve their short- and long-term objectives, with a proven track record of success. Contact Stream’s South Florida team today to learn more.
Jason Warren is Head of Strategy and Analytics for Stream’s South Florida team, using finance, analytics, and forensic due diligence to provide clients and brokers with insights that serve as a foundation for more educated real estate decisions.