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Commercial Debt: The Next Big Wave

Commercial real estate markets lag behind residential real estate markets anywhere from six to nine months. As home prices started to slide dramatically in late 2006 and early 2007, it was not too long before commercial real estate prices began to hit a brick wall. During late 2007 and in full force during 2008, commercial real estate values were in a downward spiral. Similarly as the residential debt bubble had already popped due to a wave of maturing short term loans and no option for affordable re-financing, the commercial real estate debt bubble is nearing its maximum pressure point.

Approximately 2.5 to 3 trillion dollars of commercial real estate debt is maturing over the next six to nine months. The aftermath of this amount of debt reaching its maturity date is unknown. Well-capitalized landlords or landlords who don’t require re-financing will weather the storm. However, highly leveraged investors without sufficient cash reserves that must deal with a maturing loan will have a difficult time finding new money. Building owners unable to re-finance their debt will likely work out a one or two year note extension with the lender or the lender may sell the note for less than face value. Although foreclosures will occur in the commercial markets, the frequency will be less than in residential markets. A highly leveraged building riding on thin ice could be a disaster for tenants. As loan maturation dates near, building occupants should understand the following factors before entering into lease negotiations:

1. Hold On

Rental rates will continue sliding through mid 2010 or at least remain flat. Concessions for credit worthy tenants will continue. Tenants who are stable may consider locking in for a longer lease term.

2. Underwrite

Similarly, as landlords underwrite a prospective tenant’s financial performance, it’s important for tenants to investigate the landlord’s financial stability. Conduct the necessary research or ask your advisor about the landlord’s financial position and the capital structure for the prospective property. A landlord holding a troubled asset may downgrade the operation and maintenance of the building to conserve cash.

3. Be Patient

Deals take longer in today’s market. Tenants negotiating on space should qualify the debt structure (if any) on the prospective property and understand what involvement the lender has on approving the proposed lease economics. Some lenders take a significant amount of time to approve a lease in today’s market and may try to alter the deal points at the last minute.

4. Get a Seat at the Table

Tenants seeking larger blocks of space or requiring substantial improvement dollars should have dialogue with the lender during negotiations to ensure the landlord can perform under the lease.

5. Non-Disturbance Agreement

This agreement is between the lender of the building and the tenant. The contract protects the tenant’s lease rights in the event of a foreclosure. The Non-Disturbance Agreement should also protect against free rent or tenant improvement dollars due.

6. Offset Rights

Landlords unable to fund tenant improvement dollars due should have the tenant offset these monies from the monthly rent until paid in full. Make sure to negotiate such language into the lease.

7. Lease Re-Structure

Tenants who desire to re-structure their lease prior to expiration will have an easier time with a well-capitalized landlord versus trying to negotiate a similar deal with a lender who has ultimate authority.

The commercial real estate loan bubble will not have a detrimental effect on every building or landlord over the next year, but will definitely have an impact on the overall market condition. Given that tenants are the life blood of any building, it is vital for companies to understand the make-up of a prospective landlord to ensure what precautionary steps should be taken when leasing space.

Scot Ginsburg is a senior vice president of Hughes Marino, an award-winning commercial real estate company specializing in tenant representation and building purchases with offices across the nation. Contact Scot at 1-844-662-6635 or scot.ginsburg@hughesmarino.com to learn more.



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