The underlying issue that holds the keys (literally) to commercial real estate’s future is how the buildings purchased during the “bubble” will survive the economic storm that is creating vacancy throughout the globe. And, because businesses soaked up large chunks of space that they no longer need, how will the continuing business defaults on contracts, consolidations, and bankruptcies, coupled with weak demand for space affect landlords decisions on how to price the vacant property?
Some things to keep in mind…
Most commercial loans have a term of 2-7 years, and obviously financing has become increasingly difficult to find and more expensive to maintain. Not only did newly constructed buildings and recent sales become over-leveraged by cheap financing during the last 5 -7 years; many long-time landlords refinanced their buildings during this period as well. A majority of landlords (even in Houston) that bought, built or refinanced during this period have at least one of two problems:
- Their loan is about to expire and they can’t renew it without injecting more equity, escrow or deposits…or they may not be able to renew it at all.
- They’re in technical default. In this case, they’re paying their debt service, but have exceeded their Loan-to-Value threshold (the value has dropped) or Debt Coverage Ratio (not bringing in enough rent to cover the debt payments).
In either case, renewing a tenant or signing a new tenant below market turns a theoretical loss in property value into an actual loss, as they’d be locking in lower cash flows and a lower than originally expected sale price.
Willing to wait…
Most landlords (whether a REIT, insurance company, pension fund or private equity firm) are some form of partnership. Thus, decisions involving whether or not to enter into a transaction are rarely made by a single individual. In addition to the vast majority of owners needing their lenders’ approval, they also need approval from their equity partners. Are the partners willing to lock themselves into a loss, or would they rather take their chances on market recovery? If a transaction will trigger a lender requiring them to infuse more equity, that could also be a reason to wait.
Buying to Sell…
Just as an owner doesn’t want to show a loss to his lender, he doesn’t want to lock himself in to a lower sale price by signing a lease that will yield him (and a future owner) to a lower net operating income. Many people don’t realize that most of the investment return is not made from rent—it’s made from capitalizing the net operating income upon disposition.
No Leniency…
Cutting one inexpensive deal with a tenant could lead to several more inexpensive deals with both existing and prospective tenants in the future, especially when tenant representatives get hold of the information.
Landlord Representatives…
Most of landlord representatives list multiple buildings, usually in the same market. They not only sometimes believe their market is worth more than it is, but also have an incentive to not inform particular landlords they’re representing of where the market really is, so as to “make a market” for other listings not to be discounted by less expensive transactions.
Tenants Looking for Deals on the Market…
So, say the competing landlord, that is not encumbered with debt, can move with the market by reducing rates to keep their building(s) close to full. As tenant representatives, we are aware of landlords that are well positioned to capitalize on today’s market by offering market, below market, or significantly reduced rental rates to qualified tenants.
