The Dangers of Ignorance in Commercial Real Estate

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Do commercial tenants recognize the dangers associated with not understanding the creditworthiness of their prospective, or even their current, landlords?  Standard operating procedure for most landlords is to gather financial information on prospective tenants and assess their associated risk before entering into leases.  Historically, commercial landlords, as a group, have been considered to be financially stable. Tenants didn’t concern themselves with the possibility of landlords becoming insolvent.

Despite some reports of stabilizing markets, in most of the country commercial real estate vacancies continue to rise, albeit at a slower pace. Demand for office space remains very low, with little change foreseen in the short-term. A substantially lower percentage of new leases are being completed than in previous years. Many lease renegotiation transactions are taking place throughout the United States.  Lease renegotiation transactions often result in longer leases for less space. While modifying existing leases in this manner could have long-term positive effects on landlords and the values of their buildings, the short-term effects of higher vacancies and the resulting lower positive cash flow could lead to devastating results for some landlords. In the current global economic environment, many companies (tenants) previously considered to be rock solid are experiencing severe financial challenges. Most landlords are stepping up their focus on tenant creditworthiness and are modifying how they negotiate leases to protect themselves.

I’ve heard from commercial landlords that few tenants, both those engaged in negotiations for new leases and those seeking to renegotiate existing leases, request financial information from those landlords. Why not? Since most landlords are not publicly held, this lack of inquiry can’t be because tenants are satisfying themselves with publicly available information. Are most tenants just happy idiots? Are they not aware that like any other companies that require sustained revenue, landlords can become insolvent, too? Are tenants completely confident in the landlord industry, the economy, or the bankruptcy system, such that they don’t feel the need to conduct due diligence into the financial backgrounds of their commercial landlords?

Are commercial tenants completely ignorant to the dangers and risks of buildings in financial distress and landlord insolvency?  Are they simply not aware that when landlords become insolvent, it does not happen in a single day, nor does the situation get resolved the next day?  Both the financial decline and the eventual resolution of a landlord bankruptcy typically occur over extended time periods, and are most often accompanied by significant declines in building services, repairs, response times, and more.  And, during bankruptcy and receivorship, the transitional states in which commercial buildings can find themselves often create extreme challenges to tenants’ operational efficiencies and employee productivity.

Are tenants also aware that, depending on the terms of their leases, in a landlord bankruptcy or similar legal action those leases may be terminated with no recourse by the tenant and no reimbursement for leasehold improvement costs incurred by the tenant?  Are tenants cognizant of the risks associated with the fact that most building leases limit the liability of landlords to their equity in that building alone, which equity is typically the first element to be eliminated in bankruptcy,  thereby often leaving little or no recourse against landlords by tenants?

Are tenant advisors and legal counselors not properly cautioning commercial tenants as to the very real dangers associated with potentially insolvent landlords?  Well?

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About Real Estate Strategies Corporation
Real Estate Strategies Corporation is a respected corporate advisory and transaction services firm that provides thought-leadership, decision-making, planning, project management, and transaction execution services to finance and senior executives at management team-led public, private, and portfolio companies, and not-for-profit organizations.  Under the leadership of its award-winning CEO, Andrew Zezas, RealStrat’s clients engage the firm when acquiring, disposing of, renegotiating, or enhancing occupied leased or owned real estate in New Jersey, Pennsylvania, New York, Connecticut, and throughout North America.  By creating and executing Business DRIVEN Real Estate Solutions and identifying hidden Opportunities, RealStrat drives greater operational and financial performance in support of its clients’ stakeholder objectives, M&A requirements, and exit strategies.

In the current economic environment, RealStrat’s efforts are focused on uncovering, capturing, and re-purposing hidden liquidity and minimizing risk in its clients’ leased and owned real estate.  The firm provides counsel as to competitive advantage strategies in preparation for the eventual economic recovery.  Visit www.RealStrat.com. Follow CFO Studio at http://www.Twitter.com/CFOstudio.

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