As billions are set to mature within commercial real estate-backed loans, tenants are putting extra scrutiny on prospective landlords’ financial wherewithal before signing leases.
And while a preference for the newest or most-updated office towers that offer a bevy of amenities remains prevalent among tenants, so too is the appeal of leasing space from a landlord with limited or even no debt on the building.
A recent analysis by Avison Young found 52% of the nation’s Class A office properties were encumbered by a distressed commercial mortgage-backed securities loan. Class A properties collectively represent 43.7% of the overall U.S. office market.
Avison Young also found 77.4% of all distressed loans have fixed interest rates, with the average loan on a now-distressed office property originating in January 2017.
Mark McGranahan, principal of landlord representation, office leasing and occupier services at Avison Young, said many of the newest, so-called trophy towers in today’s market are owned by landlords on solid financial footing because newer buildings today have cost so much to build.
“They’re typically very financially stable,” McGranahan said. “Usually, that’s less of an issue there, but there are certainly exceptions to that.”
But some Class A properties could draw scrutiny from tenants given the structure of their financial backing.
In San Francisco, for example, there are high-quality buildings that traded at the top of the market before the pandemic, which required owners to take on extra debt — sometimes a loan with a short-term maturity, McGranahan said. Those buildings are now facing refinancing within very different market conditions, including a significant value deterioration.
The appraised value of the 1.6 million-square-foot One Market Plaza office complex in San Francisco was $1.25 billion as of Feb. 15. That’s down nearly 29% from the $1.76 billion it was appraised at in 2016, when The Goldman Sachs Group Inc. originated a $975 million loan for joint owners Paramount Group Inc. and Blackstone Inc., the San Francisco Business Times reported.
The appraisal occurred when the owners earlier this year agreed to pay down the loan on the property, allowing them to secure a three-year extension on the loan’s maturity date. Many landlords are negotiating extensions on their office loan maturity dates, even for debt considered distressed.
Had One Market’s owners not paid down that debt, McGranahan said, companies likely would still be interested in leasing space at the property, given the pervasive flight-to-quality preference, but the debt situation might have made some groups more hesitant.
Tenants and their representatives are generally expecting more landlord transparency during the negotiation process, he said — a sentiment echoed by other real estate industry executives,
“The bigger, more sophisticated landlords that have … been around a long time are addressing the issue a little bit more head on,” McGranahan said. “Instead of hiding the ball, they’re coming forward and trying to use it as a positive marketing mechanism. Where it gets a little bit more opaque and hard to read is those smaller developers or people that maybe are apt to be more private.”
Subordination, non-disturbance and attornment agreements, or SNDAs, have become more commonplace when tenants negotiate for space in today’s market. Signed between tenant, landlord and lender, SNDAs protects a tenant’s right to the leased property if the building goes into foreclosure or if a landlord defaults on its loan. Separately, some tenants are requesting their money to go into an escrow account, McGranahan said. Others are looking to include a determination option in their contracts that allows them to terminate their lease if a landlord doesn’t fulfill its obligations.
In at least a few instances, buildings that aren’t the newest or most flush with amenities may be winners strictly because their ownership groups have little or no debt.
McGranahan said debt-free buildings tend to be older buildings that are third- or fourth-generation owned. City National Plaza, which consists of twin office towers in downtown Los Angeles, was built in the early 1970s and, as of April, had an average occupancy of 90%, according to Avison Young. That’s significantly higher than downtown L.A.’s average office-market occupancy of 72%.
City National Plaza is owned by the California State Teachers’ Retirement System, which owns the property almost outright.
