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    Leasing risk takes center stage as change sweeps the real estate industry

     

    Innovating to Meet Uncertainty

    Rent reform just passed in New York, prompting headlines of “Market Reckoning,” threats of lawsuits by numerous landlord groups, and praise from renter advocacy groups. However, it remains to be seen who will bear the brunt of the impact. Multifamily operators are understandably concerned about the impact of these changes on their business. Renters (and prospective renters) also face uncertainty, as it will become more difficult to qualify for an apartment, and owner-operators may be less motivated to invest in current or new inventory. 

    Landlords used to rely on extra security deposit and prepaid rent to hedge their risk against defaulting renters. Likewise, renters, who for whatever reason did not meet a landlord’s credit requirements, relied on those same tools to access apartments that would otherwise be out of their reach. Prepayment and extra deposits are no longer legal under the new regime. To complicate things further, the risk and downside of a lease default also increased, given that eviction times have been significantly extended. Bigger picture, with more risk and fewer options to manage that risk, landlords have had to quickly shift their thinking on their leasing operations from end to end.

     

     

    As an industry, two things are clear in this time of uncertainty: (1) There needs to be a better way to size the risk of renter default, and mitigate it accordingly–one-size-fits-all or cookie cutter solutions are a thing of the past; and (2) whatever new tools emerge, they need to address the needs of both landlords and renters, by empowering leasing staff to quickly (and affordably) provide access to a broader pool of potential renters.    

    “This reform will be a bit of a shock to landlords and their overall operations,” said Bob Schmidt, Co-Founder and Managing Director at TheGuarantors. “However as partners, it’s our goal to find creative and innovative solutions to address whatever the market throws our way.”

    TheGuarantors is a fintech company that has specialized in qualifying previously unqualified renters through its risk mitigation programs. TheGuarantors led with its flagship product, a lease guarantee, almost three years ago, but has evolved significantly since then, using better data and a deep bench of risk, real estate and finance expertise. “One of the things we’re really proud of is our new Dynamic coverage,” Schmidt continued, “the goal is to calibrate the landlord’s protection to match the risk–using a combination of our own expertise, as well as the landlord’s own preferences and experience.”

    According to TheGuarantors’ website, Dynamic lease guarantee allows landlords to select its coverage levels from as little as 3 months rent protection to as much as the full value of the lease. In the context of the new rent laws, it’s potentially another way to protect against default, that does not require a renter to hand over a pile of cash to a landlord (and all the baggage that entails).

    The challenge is of course getting landlords to innovate in-kind, but the upside is a more efficient solution to an old problem. With the new legislation, however, landlords will need to do some things differently. Daniel Rivera, a Managing Director at Bridgeline Management, points out that “with the passed legislation, our clients will have to alter their current business models to be successful. However, leasing activity will still remain strong, if we’re open to new solutions, and we can identify innovative players in the ecosystem.” 

     

    A New Era of Tenant Amenities 

    To be clear, multifamily and residential landlords are not the only ones being forced to adapt. It may be yesterday’s news (for the moment), but the office leasing landscape is changing significantly as well, and so are the risk management challenges. Lease terms are shortening to meet the demands of companies who are unwilling (or unable) to sign ten year terms, as they prioritize the need to be nimble in an uncertain market. Flex leasing is no longer the sole domain of coworking giants–industry incumbents CBRE (Hana), Tishman Speyer (Studio), and Boston Properties are only the latest to launch their own flexible office brands, together with the most recent entrant, Hines

    VTS Marketplace is poised to bring a great deal more transparency to the industry, as well–the idea is to host the entire leasing process online, giving a single platform for all parties to collaborate and close deals in a more efficient manner. In short, commercial real estate is evolving quickly to meet the demands of sophisticated and tech-enabled tenants that have landlords and brokers vying for their attention. The number of asks, features, amenities, deal structures, services and revenue models is increasing, which means that landlords are under pressure to innovate across the board, without the benefit of taking a wait-and-see approach.

     

    At the same time as leases incorporate cold brew, pet amenities, meditation rooms, and rooftop yoga, the financial and risk-management aspect of moving and securing a lease has been largely ignored. Costly security deposits feel outdated and clunky to tenants and are often a deal breaker, when they get bundled with an expensive TI or other concessions that tenants increasingly expect. Landlords feel like they are taking on even more (and unfamiliar) risk at the same time as they are being asked to compromise on their protection. 

    That mismatch between landlord and tenant on the question of security is not entirely surprising. Letters of credit were never meant to be a tenant-friendly product–quite the contrary, they are as landlord-friendly as possible, and generally reflect the landlord-friendly era when they first became the market standard. 

    In other words, consensus is that the commercial security package is in need of an update. There too, TheGuarantors say they can help. Securiti is a new offering that is meant to replicate the coverage of a traditional letter of credit, without all the costs and headaches of letter of credit. Again, with better data, technology and expertise, TheGuarantors believe they have created a product that gives the landlord all the downside protection that landlord’s know and love, without requiring the tenant to hand over a pile of cash (either to the bank or landlord). 

    “Letters of credit are brute force instruments–they cost way more, in time and money, than they need to,” says Kevin Chin, VP of Sales for Securiti, “and while that used to be the tenant’s problem, now the market is such that the tenant’s problem is the landlord’s problem.”

    Again, the challenge is in moving a traditional industry to innovate in ways they haven’t thought necessary, but therein lies the opportunity for those who are ready to lead the pack.