Until about 18 months ago, New York City office building owners
didn’t have to worry too much about their tenants’ ability to pay rent.
For financial service companies, law firms and retailers, the money was
flowing in and their demand for space was strong.
Now, of course, the picture is different. Pillars of the American
economy — from AIG to General Motors — have collapsed, and it’s
difficult for landlords to discern which tenants are truly
creditworthy.
“The question is: ‘What [is] good credit?’” asked Frank Mancini,
executive managing director of Grubb & Ellis. “A year ago, AIG was
much more creditworthy. A lot of millionaires had good credit until
Bernie Madoff came along and impoverished them.”
Building owners and their leasing brokers can perform due diligence
on prospective commercial tenants, especially publicly held companies.
“Sophisticated landlords will have an in-house risk manager, COO or
dedicated financial team looking at the audited financials of an
established company and the business plan, track record of personnel
and pro-forma earnings estimates of a new company,” said Cynthia
Wasserberger, managing director at Jones Lang LaSalle.
For smaller and medium-size companies, landlords must take it a
step further and look at the personal finances of the potential tenants
as well, said Jake Harrington, director of business development for
On-Site.com, which helps landlords screen tenants in New York City.
“These guys generally have their personal and company finances
intermingled,” he said.
However, in this economy, there’s no guarantee that today’s Google
won’t turn into tomorrow’s Lehman Brothers. Whatever the screening
process, “a lot of things happened in 2008 that were unforeseen,”
Wasserberger noted. “Hopefully we can use that as a learning
experience, but there is no crystal ball.”
When financial firms — from commercial banks to hedge funds — were
flying high, it made sense for landlords to regard these firms as their
strongest tenants.
“There is a reason why tenants with investment credit [typically
insurance firms and investment banks] didn’t pay security deposits,”
Wasserberger said. “Whether that changes is something that will be
looked at.”
There is, however, one huge factor preventing landlords from
tightening their standards when it comes to who they’ll accept as
tenants: Demand for commercial space is slipping fast. Manhattan office
vacancies rose to 7.6 percent in the fourth quarter, the highest rate
since 2004, according to data from CB Richard Ellis.
“Two things have changed,” said David Hoffman, executive managing
director for Colliers ABR. “First, landlords who are potentially in
distress will be less choosy — to the extent their lenders will let
them. Second, tenants have more leverage to drive down their security
deposits and letters of credit more quickly.”
Case in point: “I just did a deal where a tenant negotiated an accelerated burn-down of their security deposit,” Hoffman said.
Some building owners have turned desperate. And, there is an irony
in that at the very point landlords would like to more closely
scrutinize tenants, they have every incentive to loosen their
standards.
“For certain properties, it almost doesn’t matter what the credit
is,” Grubb & Ellis’ Mancini said. (He and others interviewed for
this story generally declined to discuss specific buildings, owners or
tenants.)
To be sure, landlords do have several ways to protect themselves.
“When you feel that the tenant has some type of problem that would
restrict their ability to perform, sometimes you avoid putting as much
money into a deal,” said Brian Waterman, executive vice president of
Newmark Knight Frank.
“Sometimes you ask tenants to fund improvements themselves, or ask
for a greater security deposit, or reduce a concession package. There
are multiple ways you can reduce your exposure.”
Landlords who are afraid that a tenant may go bankrupt often ask
for a letter of credit rather than a standard security deposit. That’s
because a company’s bankruptcy may allow it to avoid forfeiting a
security deposit but doesn’t affect the obligation of its bank to pay
out a letter of credit.
However, in these perilous times for the financial sector, even
that’s not a surefire strategy. What if the bank issuing the letter of
credit goes belly-up? “I still haven’t received a clear answer on that
one,” Hoffman said.
It’s worth noting that not everyone views a 7.6 percent vacancy
rate as cause for panic. “There are some big companies getting hurt,
but thousands of firms are making profits,” said Norman Sturner,
managing partner for Murray Hill Properties, which owns 5 million
square feet of office space in Manhattan.
Even for companies experiencing financial difficulties, “unless
they are in bankruptcy proceedings, a lease is a lease,” he points out.
“They have to pay rent.”
General Motors offers a perfect example. “They’re one of our
tenants, and they’re paying their rent. I don’t worry about them,”
Sturner said.
He’s not about to shy away from other companies in the industry, either.
“There are plenty of healthy automakers,” he said. “If Volkswagen
or Ferrari walked in tomorrow, I’d welcome them with open arms.”
Still, Murray Hill has loosened its standards a bit. “In this kind
of market, a lot of the time you take chances on tenants that might not
be as financially strong as you like,” Sturner said. “But perhaps
they’re willing to put up a major security deposit, with a burn-down
over time. We do a lot of financial engineering.”
It’s all about trade-offs, said Wasserberger of Jones Lang LaSalle.
“Landlords are spending more in this market on customized space and
free rent,” Wasserberger said. “Concession packages have gone up. We
can be aggressive in structuring deals, but we need to be fiscally
conservative in how we secure them.”
While landlords will take rent checks from whence they can get
them, they will be leery of financial services and law firms, some of
which also have struggled during the financial crisis, Wasserberger
said.
“Landlords may look at financial firms and law firms a little
differently now, and are less likely to take what they say at face
value,” he said. “For example, how likely are private equity firms to
raise funds?”
Still, thanks to the financial crisis, tenants have moved to the catbird seat.
“Right now it’s more of a tenant’s market,” Mancini said. “When the
real estate market is tighter, landlords can demand more. But now, if a
landlord wants a guarantee, a tenant can just go down the block and not
give a guarantee.”
