Leasing In A Down Market: How To Manage In A Shaky Economy

Presented by Charles King, David Vieweg, Joseph Chandler, and Nicolas Hoskins

Maintaining Discipline

It is just as important in a weak market as in a strong market to adhere to established norms of commercial leasing. The lease must pass muster with lenders and buyers when conditions improve.

Holding The Line

Lease components that must be preserved

and protected include:• Lender protection provisions, such as notice and

opportunity to cure, subordination and estoppels• Managing use restrictions to prevent conflicting

exclusives, to protect tenant mix, and to avoid changes in risks associated with changes in use

Holding The Line

• Addressing insurance/risk management issues, including:– Required coverages– Interaction of insurance plan with subrogation

waivers and indemnities– Sensible process for dealing with casualties

Holding The Line

• Properly manage the design and construction process:

~ Minimize impact of delayed delivery

~ Control exposure to cost overruns

~ Keep project on schedule by controlling tenant delay

~ Clearly define allocation of design and construction responsibility

Holding The Line

• Clearly allocate maintenance and repair responsibilities

• Protect against deferred maintenance with a structural reserve if appropriate

• Properly address excise tax obligations (despite the errors in commonly-used imported California lease forms)

• Manage operating cost pass-throughs

Holding The Line

preserve flexibility to make changes for the good of the project, as that may now be more important than ever.

Room To ManeuverA successful landlord will find ways to be creative and flexible in a down market.

Opportunities for deal-making in a tenant’s market include:

• Being willing to negotiate early termination options with an appropriate termination fee for a tenant whose space needs may change

Room To Maneuver

• Consider granting rights of first offer or the equivalent for expansion in office projects, taking care to keep them consistent and manageable, but avoid rights of first refusal like the plague.

• Negotiate caps on past-through items to absorb some of the risks of increases but try to limit those caps to the initial term.

Room To Maneuver

• Be willing to use a rental structure in the near term that reflects lower market demand but attempt to preserve the rental stream value in the long term:

– In appropriate cases, include percentage rents to capture some upside

– Resist fixed-rate renewal options

• Fold excess construction costs into rent, effectively becoming the tenant’s lender

Room To Maneuver

• Address excess office building load factor with an artificial R/U factor to remain competitive

• Find a way to accommodate more aggressive retail co-tenancy demands, perhaps with a development contingency to protect against failure to satisfy co-tenancy

• Be willing to take a hard look at proposed changes that would prompt a reflexive “NO” in a strong market. BE PRACTICAL!

Meeting New ChallengesOperating and marketing in a down market requires a shift in emphasis:

• Conservatively evaluate phasing of new projects to avoid having development overtake absorption rate

• Abide by stricter pre-leasing standards for new projects

• Reevaluate potential uses for existing project or conversion of existing project to a different concept altogether

Meeting New Challenges

• Specifically target those potential tenants who might previously have considered a condominium unit as an option, given changes in the financing markets

• Increase vigilance with respect to tenant defaults: once behind, it is difficult to catch up

• Stay in closer touch with tenants in order to better anticipate tenant failures

Meeting New Challenges

• When negotiating extensions, clearly analyze all of the costs of replacing major tenants who have the opportunity to relocate

• Beware of holding out for above-market rent in a falling market

• Beware of having leases prepared by inexperienced or unqualified personnel in an effort to save money on fees – doing so could turn out to be an expensive decision

Anticipating Tenant Bankruptcy

• Be on the lookout for possible bankruptcy• Be diligent about providing default notices• Consider using lease termination to avoid

having the premises dragged into bankruptcy

• Post-termination (or default), balance the risk of a lockout with the costs of an eviction action

Now That The Premises Is In Bankruptcy

• The Automatic Stay: If a bankruptcy sneaks up on you, make sure to stop collection/eviction activity and to contact a lawyer.

• Getting Paid Going Forward: The tenant must pay rent post-bankruptcy petition, but will it? The obligation can be enforced, but it can take time.

• Lease Assumption or Rejection: Tenant must cure defaults to assume the lease. Rejection gives the landlord an unsecured claim subject to a statutory cap.

Questions and Answers