Here's How Tenants Can Guard Against Precarious Landlord Situations

Many office tenants and landlords are in – or are entering – precarious positions given today’s economic situation.

A recent report from Savills said the combination of the precipitous drop in income received, higher interest rates, and consequential decreased valuation, limit an owner’s ability to refinance its debt obligation.

It also is placing the banks in a position where they may elect not to recapture the troubled asset due to the negative stigma it carries which in turn may affect its ability to lease the asset in the future.

There are steps tenants can take to better handle these situations.

Landlord/Lender Restructuring

Lenders typically complete a highest and best-use analysis to determine if the building will have a higher valuation as a conversion to residential and/or sell to an investor, which could result in the lender foreclosing on the property and possibly selling the asset.

An ill-prepared tenant that unfortunately signed a lease with a landlord that is undergoing this restructuring process could end up with substantial delays and possibly be faced with a termination of its lease.

In this case, Savills said, the most ideal scenario is to obtain a short-term lease extension under reasonable terms with its current landlord or be faced with holdover rents (typically 150% to 200% of its current rents) or be forced to go completely remote work based while the process is resolved.

Company and Financial Review

Landlords fully investigate the tenants they lease to. And tenants should complete “the same rigorous review process” on their landlords to confirm that they are capable of both funding concessions and maintaining the building for the duration of the lease term, Savills said.

Publicly traded REITs have readily available financial statements or traceable debt. Otherwise, tenants should require that landlords present both their financial and managerial capabilities, which should include a review of their financial statements.

Negotiation Process

In many markets, landlords are being incredibly aggressive with their concession packages to induce a tenant to make a long-term commitment to their building.

Savills said that tenants must maximize their leverage during negotiations as there have been times when landlords backed away from the concessions that were offered due to either a decreased valuation of the asset or the lack of lender approval.

Landlord Funding Protection

It is not uncommon for a tenant’s construction costs to exceed the value of the improvement allowance being offered by the landlord.

Savills said tenants could pay for the full cost of the improvements and then be reimbursed by the landlord in a one-time payment after construction. Or, they could take draw payments from landlords during the construction period.

Operating Expenses & Taxes

Tenants should maintain flexible audit rights that help prevent a landlord from passing through expenses that should be their responsibility, Savills said.

Be mindful that from an operating expense perspective, tenants should put caps in place for percentage increases, and annual estimated payments should not be increased or modified until the tenant has received its annual reconciliation. It should come with supporting documentation and ample time to review.

Landlord Services

Tenants need a clearly defined scope of services in their lease document with self-help rights, landlord default language, and a termination clause in scenarios of non-performance, according to the report.

These services must be as detailed as possible and include an array of items including but not limited to, building access, security, janitorial services, HVAC performance, and operation of building amenities (i.e. café, fitness facility, and conference facility).