Monthly Archives: February 2010

Breaking Up Is Hard To Do – Sometimes

Can't we just sublease?

In this environment where the deals are hot, hot, hot, it would seem difficult to “go long” with a landlord and commit to a 10 year or even longer lease. While the benefits of locking in the low cost environment will clearly be the gift that keeps on giving, how do you know what your business will look like in 12 months much less 10 years? How do you know how many employees you will have, and what happens if the whole space just doesn’t work anymore?

If business leadership is going to be able to reasonably commit to a long term lease, then they will need real estate to provide flexibility to both grow and contract over the term of the commitment. We describe three fundamental strategies to provide flexibility in this post. Please be aware that few things in life are simple, and almost nothing in a lease is simply stated. Make sure you have good representation – both real estate and legal – before you attempt these strategies for your company.

Sublease. A sublease allows the tenant to lease all or a portion of the premises to another tenant. While this might seem like a logical approach – after all it is your space – the first issue is to understand that you are competing with your own landlord. The ownership is in the business of leasing space for a profit, and you are trying to offset a cost. In most all cycles of the market you will need to sublease your space for less than your current rate, and likely less than the landlord is leasing space for in the rest of the building(s).

One of the real keys to a tenant advantaged sublease provision is attempting to get the right to sublease to others currently in the building. Again, the landlord views this as a competitive situation and will be very reluctant to provide this option. Also, be very clear about when you can continue negotiations with companies from outside the building. Some landlords will restrict you from subleasing to another company if the landlord makes a “proposal” to them. Does proposal mean oral, written and what happens if you were proposing first? All things to work out before you need to sublease.

While there are many other issues in the sublease arena that tenants need to be aware of, the other big league item of note is notification. When you make a deal with a subtenant, the landlord must approve the transaction. You want to hear from the landlord within a very few days (as opposed to say 30) because everyone wants to get on with it. Except the landlord who likely wants your deal to happen. Tell the landlord that you are willing to give them a reasonable period of time, but you are paying for this lease, and the ability to sublease is an important part of the deal. Time kills all deals, so negotiate a quick answer up front.

Expansion. Getting too big for your britches? Well, at least in the corporate sense this is a good thing. When you leased the space way back in 2010 it seemed just right, but now you won that big contract and now you need to hire a squadron of people. Why don’t you just ring up the landlord and ask for more space? Because markets change and you lose leverage when you have committed to a building.

So, pre-negotiate the ability to grow under favorable terms and conditions. There are a number of devices to accomplish this goal including a so called “must-take” which compels the tenant to expand on a certain date under agreed upon deal terms, a “right of first option” which give the typical tenant the option to take space when it first becomes available and a “right of first refusal” which allows the landlord to continue and market space but gives the tenant the right to jump in front of any other interested party.

Termination. If they space no longer works at all, or if it is surplus then a tenant can negotiate a right to terminate the lease with a payment. Most terminations options today will call for a certain date on which the lease can be ended and a formal notice provision. For example, a landlord might agree to a one time right to terminate on the 7th anniversary of a 10 year lease. Keys to negotiating this clause include: negotiating a relatively small payment compared to the rest of the remaining obligation and making sure that notice is as close as possible to the date of termination. The closer the notice, the more flexibility the tenant will have.

To sum it up, at least in the world of real estate, business can “have their cake and eat it too” by properly negotiating flexibility in leases. So now you can feel better about going long on a lease contract with favorable economics.

Ken Ashley

Emerging Trends

Hoping this graph is correct on job growth - but not cost.


Accounting firm PriceWaterhouseCoopers in partnership with the Urban Land Institute has released their comprehensive 2010 Emerging Trends in Real Estate. As you would expect, some of the report is decidedly negative and discusses such topics as “Coping with Pain.” While it might sound like a self-help book, we are after all experiencing the worst downturn in the industry in 80 years. The story of the past is written, however, and the fact that this has been and will be a tough time for landlords is not new news. 

Some points of interest from the report: 

“A sense of nervous euphoria grows among liquid investors who can make all-cash purchases..(and) if patient, daring and selective they could score generational bargains…once owners cry uncle.” 

Also on the investment front: “Don’t rush – early is the new wrong. Transactions trigger points include improving jobs numbers…and stepped up tenant deals. Ignore theory, require empirical evidence.” 

“Many real estate firms go into survival mode….demand intensifies for real estate executives who know property operations or have strong tenant and client relationships. “They keep the best and downsize the rest.” New development “doesn’t pencil out when investors can buy existing real estate in the bargain basement.” 

The report calls Commercial Mortgage Backed Securities (CMBS) financing “Frankenstein’s Monster” and calls for the “kick-the can down the road mentality” to end. It goes on to call CMBS “a huge time bomb…wrapped in a ball of confusion.” 

It also calls for debunking the myth of that diversification overcomes systemic risk — it doesn’t. “In the global marketplace, all regions and credit markets are inextricably link(ed).” We suppose real estate isn’t local after all. 

In terms of markets to watch, the report is enthusiastic about Washington, D.C. (thanks to the Feds) and calls San Francisco, Boston and New York interesting. Outside of those markets, and for the first time in memory, the report is “Not bullish on anywhere.” 

Finally, the report gives advice to both tenants and landlords in commercial space: 

“Landlords may preserve cash flows through new leases at lower rates, but could impair properties’ long term value. In some cases, (landlords) will do better standing pat. If a big tenant fails or moves out, you’re cooked.” 

Tenant’s shouldn’t “sign new leases unless they extract healthy concessions on longer terms, and should steer clear of negotiations if owners look like default candidates..” 

The authors have written a cogent, if sobering report on the real estate industry. It is, however, largely from the perspective of landlords and investors. Tenants still have an historic opportunity to reduce cost now, and with the power of a long term lease, to lock that cost advantage for years to come. 

Ken Ashley

Can We Be Transparent Here?

A new whitepaper released by Cushman & Wakefield discusses the seemingly arcane topic of lease accounting. As a result of Enron and that whole era of off-balance sheet accounting, the entity responsible for regulating lease accounting in the United States (the Financial Accounting Standard Board – FASB) is considering significant changes to the rule. If you are responsible for real estate at a publicly traded company, you might want to read the paper because as it says the proposed changes are “vast and complex.”

We at The Commercial Tenant Resource are all in favor of transparency in corporate America. However, we hope that smart real estate people will read what FASB is proposing and comment. In this highly complex area, the law of unintended consequences could certainly be a factor. Another issues is that FASB issues sweeping pronouncements that apply to all leases including such items as equipment contracts. Real estate leases are certainly different from copier leases and in the past 20 years have become immensely complex and difficult enough to handle in their own right without lots of additional regulation.

It is difficult to tell if the new standard will be adopted, and if so how it will be modified from the current proposal, but the impact on publicly traded companies and their use and accounting for real estate could be profound.

As there are significant updated to this issue we will write about them here.

Ken Ashley

Signs of Sanity

Is there debt on this building?

Many in commercial real estate watched the massive bailouts of residential loans and other “strategic” US companies such as financial institutions and auto manufacturers with a sense of disbelief. Commercial real estate types have known for months that billions in debt in their industry are at risk as well. According to a Wall Street Journal report from October of last year banking regulators “are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital.”

Finally, last week a US Congressional Oversight Panel issued a 184 page report entitled Commercial Real Estate Losses and the Risk to Financial Stability.

It’s nice to know that Congress is at least paying attention.

Some insights from the report:

“A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of every American.” Also, “…disproportionate exposure to commercial real estate capital creates negative feedback loops that suppresses economic recovery.”

Perhaps most interesting to tenants in commercial space, who, after all, are paying for the party here:

“Fewer loans to small business hamper employment growth, which could prolong commercial real estate problems by contributing to higher vacancy and lower cash flows.”

Couldn’t have said it better myself.

This report is in part the result of public hearing held in Atlanta in late January with many leaders from the commercial real estate community in attendance. According to the National Real Estate Investor, Atlanta has seen property values fall by 50% from their peak in 2007. In many ways, Atlanta is the poster child for commercial real estate woes nationwide. Partially as a result of Atlanta’s problems, bank failures have happened at a stunning rate in the State of Georgia with more on the horizon.

It is refreshing to know that Congress is finally paying attention to commercial real estate, and in fact the Congressional report on the subject is the first sign of sanity in the industry for sometime.

However, as we’ve written in this blog before the key to solving the “real estate problem” long term is true job growth. In most cases, business can’t grow without financing and it feels as if businesses are being unfairly penalized in the commercial real estate financing world. We feel like small business financing has gotten caught in the lint filter of the economy. Essentially credit needed to finance business growth appears to be hamstrung by regulators dealing with commercial real estate problems.

So, when you as a commercial real estate expert on the tenant side explain the “problem” in our area, you might remind others that growing prospering US businesses solve problems. Let’s help the public and elected officials understand the issues. Anything Congress or regulators can do to help businesses grow is better than yet another bail out.

Ken Ashley

On Valentine’s Day Tenants See Red!

The fact that the lease document is important is not new news. What is changing is what we have to focus on in the document. 

Now is clearly dangerous time to be a tenant. We still have to make sure that the document accurately reflects the business deal, but with landlords defaulting to their lenders, and with foreclosures rampant, we are beginning to see a whole host of legal issues spotlighted. If you are the person responsible for your company’s real estate leaseholds, you simply must get this right. Many millions of dollars are likely at stake, and missing some of these protections can be career limiting to say the least. 

As a general comment, it used to frustrate me to no end that landlords would create long leases with pages of tenant duties and obligations, but the landlord’s own duties or penalties for not performing were negligible. We always work hard for our clients to make the document more fair and balanced. Today, we have leverage as tenants but we must know the issues in order to protect our tenancy. You have a loaded gun, but you need to know where to shoot. 

At a recent CoreNet Global Summit, I participated in a panel along with Kitty Henry, a Partner and leasing expert of Munsch, Hardt, Kopf & Harr, P.C., and Trex Morris, who is the head of real estate in the Americas for Ernst & Young. The panel was very well received by a large audience consisting of global real estate leaders and senior service providers. The fact that they care about these issues means that we all need to be alert. 

Relationship "Map" Used in the Panel


I’m including two documents with the post: the first is Negotiating Leases During the Downturn: Creating Value and Avoiding Cost, which is the Powerpoint deck we used in the panel. The second is a wonderful supplemental piece authored by Kitty O’Henry, who is an outstanding commercial lease attorney. I have worked with Kitty on a deal where she represented the other side. She is very talented and next time I want her on our team! 

Many times lease concepts can be arcane and complex. In order to make the panel a little more fun and the lease points easier to understand, we came up with the format of a relationship between a couple and tied the lease points to different points of a relationship. We had to stretch on tying some of the lease issues to the relationship, but I bet you’ve never been to a lease class where folks laughed! They did in this one because relationships are funny many times without even trying. As far as I could tell, no one cried. 

I hope you find the attached helpful. Feel free to comment to this post with your own war stories. You can also reach out to me directly with issues or questions. 

And on this Valentine’s Day, I wish you the best for the human relationships in your life! 

Ken Ashley

Give Me More of the Good Stuff

According to this article in National Real Investor those with money in private equity are planning to invest in – you guessed it – real estate. According to the article, 41% of investors plan to increase their investment in the sector while 15% say they will maintain and 15% are unsure of their strategy. In the longer term the survey referenced in the article reports that 75% of respondents are optimistic about commercial real estate as an investment class.

What this tells me is that the pendulum is beginning to swing the other way: instead of running from the fire, investors are now sensing a fire sale. Areas that will be of interest will clearly include distressed equity but also senior debt positions.

From the tenant’s perspective this is generally good news because a sense of panic by ownership creates irresponsible property management practices. Investors who have bought “right” and who are optimistic about the future focus on increasing value in their properties. Taking care of good credit tenants is at the top of the list in creating and enhancing value.

The other issue to be aware of as a tenant is the effect investor optimism has on real estate cost (i.e. lease rates). As we have said on this blog in the past, now is the time to try and lock in low real estate lease rates. The National Real Estate Investor article above simply adds credibility to this assertion and in my mind an additional sense of urgency.

We forecast a window of opportunity for roughly the next six to nine months. After that time, (and depending on which city your facility is in) concessions will ease. It will be some time before asking rates actually rise, but most sophisticated real estate tenants evaluate opportunities based on the net cost (including concessions). So from that perspective real estate cost will begin to ease up later this year from their current inflation adjusted lows.

The bottom line is that happy, optimistic landlords are great AFTER the lease as been signed!

Ken Ashley

What makes everything OK

 With the announcement today from the Department of Labor that the unemployment rate dropped to 9.7% in January, lots of real estate types are beginning to wonder if the report is a very early signal of recovery – not just generally but also in commercial real estate. Admittedly, we have a long way to go before office using employment leads to any significant absorption, but the DOL numbers are a concrete sign. Correlate this with increased activity by office using tenants in many major markets, and we may be seeing the beginning of the end of a very tough real estate cycle.

Of course, if a recovery is underway, it is nascent and many things could set us off course. But I think you could fill many blog posting with all the dangers in the world.

The critical thing to note is that not only has office using unemployment stopped getting significantly worse, but it appears to be headed the other way. And if it keeps up, it will eventually make most everything OK in commercial real estate.

 Ken Ashley