Five Critical Steps for Lease Administration for Troubled Commercial Real Estate Assets
Commercial real estate assets are changing hands again, and not for the same reasons we saw in the go-go days of the last up cycle when multiple bidders were pushing values higher and higher. These days we read about owners handing the keys back to lenders, deed in lieu of foreclosure and foreclosure itself. Each scenario is synonymous with commercial real estate trouble, which leads to assets transferring to special services or different participants in the capital stack.
When Troubled Commercial Real Estate Assets Change Hands
When commercial real estate assets change hands under these methods, new ownership has much to get their arms around in a short amount of time. The asset has likely been struggling for a while, key line items have been cut from operating budgets to keep the asset running at the lowest cost possible, capital spend has been reduced, and property and asset managers have been trying to accomplish the same amount of work with fewer people.
Assessing A Commercial Real Estate Asset’s Lease Administration Program
When a new ownership group takes charge of an asset, they often engage a commercial real estate consultant to help them better understand the situation they have just inherited. One of the primary tasks the Realogic team is faced with when engaged by our clients is to determine the status of the asset’s lease administration program. Items such as rents, abatements, percentage rent, critical dates, options, encumbrances, future tenant improvement commitments, security deposits, and letters of credit, to name just a few, must be reviewed. Maybe the information is reliable and readily accessible. Often, it’s not.
Keeping A Troubled Commercial Real Estate Asset Functioning
What does your new ownership team need to do to keep the asset functioning, rent continuing to be paid and the leasing engine fed?
1. Choose a lease administration process and system that is as dynamic as your asset. New lease documents, amendments, subleases, letters and other leasing activity at the asset is occurring on a constant basis. Minimally you must track which documents have been executed and abstracted. Abstracts should include important lease terms such as:
- Tenant rent
- Percentage rent
- Clause lists with lease provisions
- Critical dates
This information must be available to all asset management, property management, accounting and leasing team members. Your chosen lease administration system is just as important as your lease administration process. Excel and Word are not going to cut it. We provide lease administration to our clients using our own SaaS platform, rAbstract™, as well as Yardi® and MRI®.
2. Audit rents and recoveries. It is surprising how often billing does not match the contractual lease terms. Base rent and abatement are the easiest places to start and should be reviewed immediately, comparing newly abstracted current and future rents to the rent roll as well as setting critical date reminders to adjust billing for upcoming rent changes.
Recoveries are a little more challenging for a quick fix but cannot be ignored. Make sure you review estimates for both the current and previous year, confirming any potential caps on expenses. A comprehensive audit can wait until you complete immediate tasks, but do not wait too long as you will have reconciliations coming due in the first part of the next year.
For retail properties, it is a must to understand if any tenants have a sales kick-out provision under which a tenant is allowed to terminate if gross sales do not achieve a specified sales threshold during a specified measuring period. Is the tenant in the current measuring period? What are gross sales to date? When is the termination notice period?
3. Review the terms for all tenant options, especially terminations, as well as encumbrances. When may tenants renew, terminate, expand and contract? What notice period must be given? Are there vacant suites and/or floors that are still subject to expansion rights, rights of first refusal or rights of first offer? What notice periods are required? If the new owner is trying to drive occupancy, leasing an encumbered space and/or floor is going to be a potentially expensive mistake.
4. Review all security deposits and letters of credit. Building owners should consider which institution is holding the deposits, and more importantly, which banks are issuing your tenant’s letters of credit (“LOC”). Owners may need to require their tenants to replace the LOCs issued by failed or troubled banks with LOCs drawn on creditworthy banks.
5. Do not forget these two key lease clauses:
- Subleases: Given the current market, it is important to understand what suites/spaces are currently sublet and when both the lease and sublease expire. In addition to just knowing what space is available to sublease, what are the terms allowing for sublease? Is landlord approval required? Does it impact other clauses like signage? What fees are due to the landlord?
- Tenant Improvements: Are there outstanding future tenant improvement allowances owed to existing tenants or tenant improvement work that the landlord is required to complete at the landlord’s cost? Is any unused allowance convertible to rent abatement or is it of a use it or lose it nature? What are the dates of notice? What, if any, are the sunset dates for disbursement of tenant improvement allowances?
A Final Word On Transitioning Commercial Real Estate Assets
Transitioning ownership of an asset is never a simple process under any economic circumstances. However, an abrupt transition during economic uncertainty creates additional issues and these issues may have been growing in scale as the asset moved towards an unexpected outcome.
Additional Resources on Commercial Real Estate Lease Administration
If you’d like more information on commercial real estate lease administration, there’s a helpful and informative eBook in our resources Library entitled Commercial Real Estate Lease Administration Best Practices in which our expert lease administration team shares some tips and best practices to help commercial real estate owners, property managers and investors maximize the revenue from their assets while minimizing expenses.
In addition, we’ve created a handy checklist of Ten Essential Sublease Clauses to include in commercial real estate leases, which is also in our Library.
Finally, there’s The ABCs of Commercial Real Estate Leases, our thorough and detailed primer on commercial real estate leases, covering lease basics, rent, options and more. You’ll find that in our resources Library as well.
If you have any questions about commercial real estate lease administration in general or would like information on Realogic’s lease administration or lease abstraction services or our advanced rAbstract lease administration software, email us at firstname.lastname@example.org or call us at 312-782-7325.
About the Authors
Charri Isaacson is senior manager at Realogic where her responsibilities include abstracting and administering 1,700+ leases for 31+ million square feet of commercial space for Realogic’s clients. In addition, Charri abstracts non-lease documents, and manages implementations of rAbstract, our proprietary lease abstraction and administration software, for new clients. Charri joined Realogic in 2005 and has 25+ years of commercial real estate experience, including as a property and asset manager. You can reach Charri at email@example.com.
Jim Pettinger is CEO of Realogic. He has 25+ years of commercial real estate experience, including in lease administration, lease and document abstraction, property budgeting and forecasting and in developing and implementing commercial real estate software. In addition, Jim has extensive experience in commercial real estate underwriting, due diligence, financial modeling and closing support and with financing and capital markets. You can reach Jim at firstname.lastname@example.org.