The Dangers of Ignorance in Commercial Real Estate

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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Copyright Real Estate Strategies Corporation 2010.  All Rights Reserved.

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THIS WORK IS DESIGNED TO PROVIDE PRACTICAL AND USEFUL INFORMATION ON THE SUBJECT MATTER COVERED AND REPRESENTS THE OPINION OF THE AUTHOR. HOWEVER, IT IS PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR IS NOT ENGAGED IN RENDERING LEGAL, FINANCIAL, ACCOUNTING, OR OTHER PROFESSIONAL ADVICE TO THE READER. IF LEGAL, FINANCIAL, ACCOUNTING, OR OTHER PROFESSIONAL ADVICE IS REQUIRED, THE SERVICES OF A COMPETENT PROFESSIONAL SHOULD BE SOUGHT. THE AUTHOR SPECIFICALLY AND EXPRESSLY DISCLAIMS ANY LIABILITY THAT MAY BE INCURRED AS A RESULT OF THE USE OR APPLICATION OF THE INFORMATION THAT IS CONTAINED IN THIS WORK.

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