Friday, April 4, 2014

#CRE lease termination...DON'T DO THIS!

Image attribution: swapalease.com
I experienced a situation yesterday that I believe is worth sharing.

The gross mishandling of an issue (not by me fortunately) nearly caused a fairly sizable...and necessary...deal for the owner to crater.

Luckily, we were able to salvage the transaction...not because we were concerned about getting paid...but because if this deal didn't happen, the owner's ability to refinance a maturing loan would have been greatly diminished...errr, WOODENA  HAPPENED!

The issue revolved around an existing lease term, a Fortune 500 tenant that had vacated the space and was continuing to pay rent on the vacant space, and a new tenant that we procured that needed the space ASAP...BUYOUT central!

As a disclaimer, I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I believe that qualifies me as some sort of an expert...if I can remember why...

OK, the quick down and dirty...
  • January 2014, approximately 15 months remained on a lease term with a Fortune 500 company
  • The tenant approached the property manager regarding a buyout of the remaining term of lease
  • The tenant offered $.60 on the dollar
  • Property manager asked the owner and us what to do
  • We advised the owner to NOT take the buyout because we were uncertain what a new deal would cost...tenant improvements, free rent, down time, commissions...etc. We had a Fortune 500 company on the hook that we believed wouldn't default so the income stream was secure....so why not use the time to market the space and if someone came along we could discuss a buyout...a WIN WIN for the owner.
  • We proceeded down that path 
Flash forward...
  • We procured a tenant (through "world class" brokerage, BTW)
  • We commenced negotiations
  • We reached agreement subject to a successful termination of the Fortune 500 tenant's lease
  • We computed (to the best of our ability) the cost of the new deal with an estimate of construction costs for the tenant improvements, free rent, commissions, and transition time
  • We arrived at a buyout amount range that would allow the vacating Fortune 500 tenant to terminate the remaining term of the lease, and the owner to use the buyout money to fund the costs of the new deal 
Perfect, right...uh, not so fast.

What happened next should curl the hair (if you still have any) of any owner, broker, or competent property manager.

Without prompting (quite the contrary, we asked them to do the opposite), the property manager contacted the Fortune 500 tenant...told them we had secured a new tenant that wanted their space in 30 days, gave the Fortune 500 tenant notice that we needed the space by the end of April...Oh, and by the way...can we please discuss the buyout of the remaining lease term?

ARE YOU EFFING (sorry Duke) KIDDING ME? The earth movement you felt a week ago was not an earthquake but was our owner reacting...not pretty! The owner was livid but his "lividity" was about to be ramped up to DEFCON 5 the next day as...you guessed it...when the Fortune 500 tenant's buyout was discussed, the Fortune 500 basically said to pound sand! Our negotiating leverage was lost. The deal now was in serious jeopardy because the Fortune 500 tenant threatened to simply "ride out" the term and not consider an early termination and buyout.

After some colorful language, a serious scolding by the owner (of the property manager...not us), and the owner in essence telling the property manager that the issue better get resolved or...

I am pleased to report that we convinced the Fortune 500 company (we got lucky, frankly) to terminate early, and provide a reasonable buyout which will allow the owner (albeit not as effectively as anticipated) to complete the deal and refinance his property.

So what can we take away if you rep an owner in a similar situation?
  • Compute the dollar amount of the remaining lease term
  • Liberally calculate the cost of a new deal (I realize you'll make assumptions)
  • The cost of a new deal, with some wiggle room, forms the amount of the buyout
  • Decipher the reliability of the remaining income stream (remember, the tenant has vacated)
  • Advise accordingly...if the income is stable (as in our deal), don't buyout.
  • Manage the buyout process yourself...don't rely on the property manager!