New York Office Owners’ Financials Under Sharper Scrutiny

David Hoffman, a vice chairman at Cushman & Wakefield (CWK), represents a boutique financial services firm that was testing the waters of a New York City presence with a short-term sublease in Midtown.

After the company decided it wanted to make the office its permanent home, Hoffman set out to convert the sublease into a long-term, traditional lease.

But, when he attempted to contact the building’s landlord, he ran into an unusual problem.

“The landlord is in the middle of a disagreement with the lender that has evolved into a stalemate, and there is nobody to speak with to renew this lease,” said Hoffman, who recalls that the tenant had a difficult time understanding this.

“Any deals had to be approved by the lender, and the lender was not approving any deals as a method to pressure the owner into agreeing to better terms,” said Hoffman. “And the tenant is like, ‘You mean to tell me that we want to stay, and it’s in the lender’s and owner’s best interest to keep the building active with rent-paying tenants, and we can’t make a deal with anybody?’ And I’m like, ‘Yeah. That’s it.’”

Hoffman notes that this sort of situation would have been unheard of until recently. He cites it as just one example of how the office leasing world has been turned on its head.

Traditionally, when tenants sought office space, the onus was solely on the tenants to prove their solvency and financial health to the building’s owner. But since the beginning of the office crisis precipitated by the COVID-19 pandemic, building owners have begun to find themselves equally under their tenants’ microscope, having to prove to tenants that they will continue to operate the building to agreed-on standards for the life of the lease.

“My original challenge 20 years ago was to find someone with the best space that met all the tenant’s requirements,” said Evan Margolin, vice chairman of tenant representation for JLL (JLL). “Now, you have to find the best space, but also diligence the landlord upfront and make sure they’ll be able to fulfill the obligations of a landlord: that they’ll be able to fund tenant improvement allowances, operate the building, and service their debt so they can continue to own the building. And if they can’t continue to own the building, then who’s going to be the next landlord? That creates uncertainty that tenants are often not comfortable with.”

Mary Ann Tighe, CEO of the New York tri-state region for CBRE (CBRE), notes the unprecedented nature of this change in the prospective tenant/owner power dynamic.

“I don’t ever remember a period where a basic filter was the viability of the entity that owned the building,” said Tighe. “We would look at what was available: location, pricing, condition of the building. But it wasn’t standard operating procedure to say, ‘What is going to happen with this building? When does this financing expire?’ ”

Tighe noted that the situation has become so unpredictable that even the boldfaced names in building ownership may face deeper questions than ever before.

“It used to be that there were people who were above the fray,” said Tighe. “If you were going to their building, you knew that they were under leverage, and it was fine. But one thing we’ve learned is that you can go to a Blackstone (BX) building, for example, and Blackstone is immensely strong financially, but there’s still a real possibility that if the capital stack of that building can’t be supported by the current leasing environment, the current rent roll, then they’ll give the keys back. And then you’re really in an awkward place.”

Indeed, Blackstone handed keys back on prominent properties relatively recently. In 2022, the firm walked away from a prime Manhattan office property at 1740 Broadway, where it had an outstanding $308 million loan. But the investment giant is hardly the only big hitter who’s done this in the post-COVID years. Running the gamut from RFR to RXR, circumstances have forced blue-chip landlords into similar decisions.

As a result, prospective office tenants and their brokers now do deeper dives into the financial health of not just the owners but also the buildings they’re considering calling home.

“I don’t know that we’ve been through a cycle where there’s been a more pronounced and visible reckoning of capital stack dysfunction,” said David Goldstein, president of the New York tri-state region for Savills. “It’s incumbent upon any occupier to understand all the nuances and the makeup of the capital stacks that constitute the financial backbone of these assets. That includes the senior debt, the mezz debt, and the equity itself.”

Complicating matters further, a tenant’s desires for an office can sometimes be cut short by the owner’s lender, a formerly rare situation that has recently become far more common.

“I’m working on a 20,000-square-foot transaction downtown where the tenant wanted a long-term lease for a brand-new space, and they wanted the landlord to build the space,” said Margolin, referring to a Downtown Manhattan address. “There are only a select number of landlords that have the funds to fund a full buildout in the downtown market today. As we went through the process, this tenant actually asked the question up front, and one building was partially owned by a publicly traded REIT with a big name. It turned out they were unwilling to fund the full buildout because lenders have to sign off on everything now, and their lender said that they didn’t think this was the best use of their funds. The tenant went with a bigger landlord that funded the buildout.”

Margolin notes that this sort of scenario would have been almost unheard of before the current office crisis.

“I’m a 25-year tenant rep,” he said. “The lender was brought up in my negotiations very infrequently. Unless they were very major transactions, most transactions didn’t need lender approval.”

One result of all this disruption is an increased sense of caution in the brokerage community.

“We do a tremendous amount of vetting upfront, and in many instances we won’t show buildings that we’re not confident about,” said Margolin. “When we are presenting opportunities, our space reports didn’t used to have a debt section on them. They do now. In certain instances, we also have a confidence level next to that, a scale of how confident we are in the ownership of the building. So, while there’s a lot of opportunity, this analysis of the debt on these buildings helps us to limit the opportunities that we’re going to present.”

For attorney Mike Lefkowitz, managing member and general counsel of Rosenberg & Estis, certain aspects of this new diligence are familiar.

“I don’t think it’s a new phenomenon,” Lefkowitz said of the need for increased diligence on behalf of prospective tenants. “Whenever you have a cycle which includes office building distress, an increase in the number of filed office building foreclosure actions, or news of office owners having difficulty refinancing without putting fresh capital into their buildings, you then have savvy tenants wanting to know if the building will become bank-owned or will go through a foreclosure.”

This is especially true if the landlord promised an extensive buildout, Lefkowitz said.

“That’s really the biggest issue, and where the tenant has to be the most careful — if they have a landlord who’s promised a fully built-out space and the space needs to be demolished and lots of dollars have to be spent to get there. That’s where the real risk is for the incoming tenant.”

As a result, the due-diligence and research phase of finding a new office for prospective tenants has become more complex and multi-faceted, with more information required before a final decision.

“The leasing process involves more parts, but the information you’re now seeking is relatively easily available online,” said Tighe. “I just sent out a survey this morning with multiple locations. We’re now routinely running through those locations with our research department to say, ‘What’s the status of the mortgage? What’s the reset going to look like? Do we believe that the landlord can meet the market?’ ”

Part of this new necessity is the consideration that a choice to extend a mortgage might require additional equity from the owner, which could become a tenant concern.

“You have to ask: Is the landlord going to value this building enough so that they’ll come out of pocket with additional equity?” said Tighe. “And, if they do that, how will that impact leasing on the building?”

That said, the public nature of much of the required information on owners and buildings makes part of this, at least, a relatively light lift for tenants and their brokers. 

“There are a variety of sources to get three-dimensional visibility into the capital stacks of these properties,” said Goldstein. “Whether it’s a CMBS loan or a balance sheet loan, a lot of these loans are securitized, which means they reside in the public realm. Having access to that information is a critical element to creating the strategic advantage of having great information.”

Margolin notes that one result of the changes is the increased involvement of capital markets teams in the process.

“Every larger leasing transaction we work on now is also a capital markets transaction,” said Margolin. “For larger transactions, we’re working alongside our capital markets team and asking them for the backstory on the building. Debt is public information — we’re able to find that information on our own —  but we ask our capital markets team what they’re hearing about the building and the landlord’s position, and getting their thoughts on the solvency of the landlord, the future of the building, and the future of who’s going to be the actual owner of the building.”

These changes have also altered the process of securing clients for tenant reps, Margolin said.

“We recently competed for a sizable tenant rep transaction, and we were awarded the job,” he said. “As a follow-up, I asked what it was that worked in our favor, as we always do. They talked about how we brought in one of our capital markets professionals as a key member of the pitch team, and how he described the diligence he would do on the buildings in advance of presenting them in order to give the tenant a better understanding of what they should be looking for, and what the risks are when they enter into a transaction with a landlord that may have either pending refinancing or a building that is underwater.”

Cushman & Wakefield’s Hoffman summarizes the current situation by characterizing the new leasing environment as requiring a whole new mindset, an updated way of thinking for any entity seeking to lease out office space.

“We took a property over for a special servicer, a significant office property that they wanted us to lease for them,” said Hoffman. “I said, ‘Great, but here’s the way I think you should approach it. We have to be able to convey to the tenant and brokerage communities that you are ready to go — that your ducks are all lined up. You’ve got money set aside for a tenant improvement allowance and to pay brokerage commissions. You’ve got a clear path to make leases without all kinds of vague approval processes. And you need to establish for the brokerage community that there is a direct straight line that’s not too long between Point A, showing the building, and Point B, finalizing the lease and getting paid a commission. If you can’t do that, you won’t lease.’

“There’s a different type of messaging that has to be conveyed in order to make prospective tenants and their brokers comfortable that they’re not wasting their time.”