As a commercial real estate broker, I’m often approached by landlords requesting that my clients pay larger security deposits or sign a personal guarantee in the event that they default as tenants. However, it’s no longer the tenant that can end up in default or in breach of their lease. Now it’s the landlord too!

The current weak economic climate and the number of landlords struggling to stay afloat amongst all their distressed assets presents a new set of challenges for commercial tenants. Landlord default is now a hugely important consideration for companies leasing or renegotiating their leases as it represents a major area of business risk generally not contemplated until recently.

With the leasing market in the doldrums and real estate prices still falling, many building owners are defaulting on their loans, have no cash at hand to manage their properties, perform tenant improvements and other financial obligations per their leases and even afford the fixed costs of leasing space to a new tenant.

So how do you, the tenant, determine which landlords to lease from and which to avoid and what extra steps does your real estate broker need to address in the lease to protect you from landlord default and the potential ensuing consequences?

Here are four important rules to follow:

1. Know the landlord

Before signing a lease, be sure your real estate broker has thoroughly researched the property and its owner. Ask to review the landlord’s current and historic financial statements if possible and ask your broker to request a property title report to confirm they are not in default on their loan payments. This will help you determine the landlord’s long-term financial stability and ability to service their debt. Also, ask your real estate broker about the building owner’s reputation. Just as the landlord will scrutinize your financials and operations as a prospective tenant, now it’s time to do the same to the landlord to ensure that when you do sign a lease you can do so knowing that it’s likely your lease rights will be upheld by the landlord.

2. Negotiate self-help or rights of recourse

In the current economy, a landlord in financial distress may reduce building services, maintenance or capital improvements to the property in order to save money. As a tenant, ensure the landlord is obligated in the lease to provide a very specific level of service. You also need to ensure that, if building services fall below the required standards, you have methods of recourse such as the right to off-set rent payments, terminate your lease, or hire someone to perform the work required at the landlord’s expense. Such rights can be difficult to negotiate for the smaller tenant however but they are important to ensure that your business can continue to operate properly in the event that your working environment is compromised.

3. Protect yourself against foreclosure

If you’re leasing space and the building enters foreclosure, you want your lease to remain valid and your rights as a tenant to be protected. As part of your landlord due diligence, obtaining and analyzing a title report to determine what, if any, loans exist on the property, is the responsibility of your real estate broker.
If there are loans in place, make sure your real estate attorney obtains a favorable subordination, non-disturbance and attornment agreement. This will offer you the protection you need in the event of foreclosure, particularly if you are investing significant money towards tenant improvements.

4. Protect tenant improvement allowances and other concessions

Landlords typically agree to pay for all or part of the tenant improvements by way of a tenant improvement allowance. Either the landlord undertakes the improvements themselves or the tenant is reimbursed by the landlord when the project is completed. If a landlord files for bankruptcy, you could potentially lose any outstanding tenant improvement reimbursement. To protect yourself, negotiate the lease or work letter to either place any tenant improvement allowance in a third-party escrow account, secure the allowance with a letter of credit or grant the tenant the right to off-set the unpaid allowance against future rent payments.

For more information on this subject, call Stefan Rogers at 949.263.5362.

Tags: building, business, commercial, cost, economy, financial, landlord, lease, manage, money, negotiate, owner, prices, property, rate, Real, Real Estate, reduce, Report, research, save, services, space, Tenant

This entry was posted on Friday, July 30th, 2010 at 2:39 pm and is filed under Corporate Real Estate Strategies. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.