The Lights Are On But Who’s the Owner?
The following article by Robert W. Thagard appeared in the June issue of REBusiness Online:
A significant portion of office market inventory in most U.S. markets is suffering through some kind of economic stress, whether due to owner financial distress, pending foreclosure, or management by special servicers or a court appointed receiver. For every office building which is enduring such financial strain or pending change of management/ownership, there are existing tenants and prospective tenants for those buildings who are greatly affected. They are thrown into a situation that presents immediate instability and long-term uncertainty. However, such circumstances can also create an upside for the tenants. Tenants may have the opportunity to negotiate a better lease situation within the property or seize the chance to look at relocation opportunities in a very competitive office market with other more financially-solvent landlords who are looking to stabilize their buildings and make deals which they need but may be very advantageous to the tenant. In either case, it is imperative that such situations be strategically managed by the tenant/user. The tenant should call upon proper legal and brokerage counsel to work with them and guide them through the course of action to protect their interests and obtain the best long term solution that safely navigates the uncertain waters of today’s office markets.
Receivership Issues
Inevitably, when a building goes into receivership, a disconnect is created between the owner and the lender. Essentially, the receiver is appointed to be the “short term caretaker” for the property. They are then responsible to oversee functions of the building such as property management, tenant relations, and other day-to-day activities in addition to the myriad of procedures relating to the property’s operational issues. In some cases an office building may remain in receivership for well over 12 months. In such cases, the uncertainty for the tenants and prospective tenants of the building may drag on for a painfully lengthy period of time.
Property Management
One of the most immediate causes for concern for tenants when their building enters into receivership is the expected level of service from the property management function for the owner/lender. Again, the receiver is now the short term caretaker and may have different ideas about how the property will be, or should be, managed. The receiver is often charged with shaving unnecessary operational costs. The building’s property management team may be reduced or eliminated and/or replaced with an alternative team. It is rare that a building would be completely abandoned, however, the level of service may change and key building functions may possibly fall into disrepair. Similarly, tenant issues may not be addressed as quickly or effectively as they were before the appointment of the receiver due to timing and cost issues.
Protecting Favorable Lease Terms
Receivers may take over responsibility for all leasing activity. This may include existing lease contracts as well as lease negotiations for new leases and renewals when lease terms roll. In a receivership situation, any new lease that is being negotiated or one that is up for renewal typically needs to be approved by the court. So, even though a lease has been negotiated – whether by the previous owner or the receiver – it will not be fully executed until the receiver goes to the court to obtain approval of the agreed upon terms. If the owner or the lender don’t like the terms of the lease or renewal, they can object.
For these reasons, if a receiver is in place or anticipated, tenants need to make sure they have ample time to negotiate the terms of their new lease or renewal. It is important for a tenant to understand the timing for the lease/renewal approval process in the context of the receiver. When a property is in receivership, the process is bound to take longer than expected. If a tenant is left without a contract signed and sealed by its internal lease deadline this delay can cause significant increased rent costs per day until a contract is signed. For example, even though a tenant’s lease might be expiring at the end of the month, the receiver might return from its court review with additional changes to the contract. This would further delay the process and might result in the lease being executed only after its current expiration date. The tenant should always make sure that in its initial lease, they have negotiated a favorable Holdover provision. In many cases, if a tenant remains past the expiration of the lease, the tenant can be charged up to two times the amount of the rent during the period of holdover. Ideally, a tenant should always seek to negotiate a more favorable Holdover provision that only calls for holdover rent at a rate of 125% to 150% percent, should the tenant remain beyond lease expiration without a new contract.
A tenant should also look to negotiate a Non-Disturbance Agreement. This agreement ensures that if the lender forecloses the lease won’t be disturbed and it will remain in full effect with the lender and any subsequent new owner. In this way, the tenant’s valuable (and often heavily negotiated) lease rights are protected. A Non-Disturbance Agreement should be written so that when a new owner does take the helm, they can’t disturb what has already been negotiated.
If a tenant is negotiating a lease for space in a building that is already in receivership, the tenant needs to be sensitive to the issue of which responsible party will actually fund the tenant improvement and broker commission costs. The contract needs to delineate where the money is going to come from and when the TIs and commissions will be paid. It should also define the ramifications in the event they are not paid, such as providing the tenant with rights to offset against rent any unpaid amounts of commissions or tenant improvement costs. Such protections should be acknowledged in the Non-Disturbance Agreement described above so that the lender and any subsequent owner are bound by the tenant’s rights to offset rent if they do not receive the benefit of their bargain for commissions and tenant improvement costs to be paid by the building ownership.
As mentioned earlier, buildings in receivership often times present a window of opportunity for a savvy tenant to negotiate a lease at below market terms, provided they obtain the appropriate protections for such terms. This situation may occur for any number of reasons; the receiver needs to hit occupancy goals and show a stable rent roll; or they may not be as focused on current market conditions. The tenant should take responsibility to educate itself about the market and any particular buildings it is considering by seeking appropriate broker assistance to evaluate alternative building owner scenarios and by seeking appropriate real estate legal counsel that can assist them in properly documenting a beneficial lease and protecting the terms of such lease as to any subsequent change in ownership of the building. .
The best scenario occurs when a tenant works with a competent commercial real estate broker who has enough in depth local market information to provide good data on each building’s ownership, value, equity and overall financial condition. In this way, a strong long-term partnership can be created with a stable owner, or with the existing transition ownership/management, which will protect the tenant and allow them to focus on their business plans and path to success without worrying about occupancy issues.
Robert W. Thagard is a managing principal and partner at ORION Property Partners. He is active in tenant representation, marketing and leasing of office properties in Orange County. As such, he has been instrumental in shaping the Orange County market and has represented clients and completed more than 10 million square feet of transactions with a value in excess of $750 million. Prior to joining ORION, Bob was Director of Leasing for Irvine Company and was an award-winning broker at CB Richard Ellis where he was recognized as “Top Broker of the Year” for six consecutive years. ORION Property Partners is a premier commercial real estate firm in Orange County. The firm provides a high level of client service in project leasing, tenant representation, and consulting, handling office properties ranging from single property to full portfolios. The team’s unique culture is focused on a select client list minimizing conflict of interest and maximizing client service and transaction success. For more information, visit www.oppre.com.
