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The Equity Virus

The San Francisco Bay Area can keep all its fog, rain, cold weather, crowded freeways, out-of-sight housing costs and other maladies — including at least one very bad critter that has begun to slither southward to our golden shores.

I am referring to the equity participation “virus” that is being used to infect office space leaseholds by a respectful number of disrespectful landlords.

I haven’t always been kind to our local crop of building owners and managers. Over the past several months, I’ve decried in this column — and rightfully so, I hasten to add — the many ways local tenants and those shopping for office space are not being treated fairly by landlords and their agents. For those who haven’t been paying attention, some of those practices include keeping leasing signs in front of buildings that no longer have available space, refusing to provide decent tenant-improvement allowances, being vague as to what constitutes a “net” or “full” lease, trying to represent both the landlord and tenant, using incompetent or insensitive building managers and even recalculating a new way for tenants to pay for space they won’t be using.

As irksome as these schemes and practices are, they pale in comparison to this landlord equity virus that hatched a couple of years ago in the Bay Area, Seattle and, more recently, locally.

Landlords have for some time shunned personal guarantees from tenants to collateralize office leases in these so-called “technology hubs” where office space is especially scarce. For that matter, some are no longer satisfied with going one step further and obtaining a third-party guarantee from banks in the form of letters of credit. They are now asking — and getting — ownership or equity positions in their tenants’ businesses as a form of security. In addition to letters of credit from banks and other third parties, landlords are now becoming co-owners in their tenants’ business.

Yikes.

These landlords are using the recent and continuing demise of many dot-com firms as a justification to minimize their risk exposure when leasing to start-up companies and those tenants who don’t have sufficient assets to guarantee a substantive obligation such as a long-term office lease.

It’s true that landlords and other creditors risk being left holding the bag, so to speak, if a tenant bails out and files for bankruptcy protection.

It is also true that personal guarantees can be problematic by being extensive and requiring protracted and costly litigation to pursue. Landlords are justified in insisting on a letter of credit from a bank that promises to cure the default if the tenant becomes unable to meet its lease obligation.

It is not appropriate, however, for the landlord to ask for both a third-party guarantee and an equity position in his tenant’s business. There are at least three reasons that make the case for landlords keeping their hands off their tenants’ businesses.

For one, landlords are in the business of leasing space and obtaining a reasonable return on their investment. They are landlords — not computer or Internet wizards, lawyers, bakers or candle stick makers. As an equity participant, the landlord only dilutes the ownership of their tenant’s business. They contribute nothing of value. No time, no talent, no treasure. Not one thing.

Second, the tenant’s security deposit, last month’s rent and a letter of credit by which a third party promises to cure any lease default are more than adequate. The landlord’s leasehold is protected. What else is needed to scratch the “risk itch”?

Third, what tangible value is there in having ownership in a company that someday may not have the resources to honor its lease obligation? Perhaps there are legal advantages involved, but from a practical standpoint, what good is it to own part of a boat that is sinking? One doesn’t knowingly seek an asset that is at risk. Again, landlords should be content with owning and leasing real estate and securing their position with appropriate guarantees and leave their tenants’ businesses to their tenants.

Fortunately, this trend so far has been relatively spotty in San Diego County. Our county’s overall 7 percent-9 percent vacancy rate still gives tenants some options.

Please, San Diego landlords, stick with reasonable lease guarantees and let’s pack up this equity virus and ship it back to where it came from.

Jason Hughes is chairman, CEO, and owner of Hughes Marino, an award-winning commercial real estate company with offices across the nation. A pioneer in the field of tenant representation, Jason has exclusively represented tenants and buyers for more than 30 years. Contact Jason at 1-844-662-6635 or jason@hughesmarino.com to learn more.



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