Headlines proclaiming the “end of extend and pretend” for maturing loans have been splashed across commercial real estate publications for over a year. And while CRE loan delinquencies have crept up by nearly 100 bps from Q3 2022 (0.63%) to Q4 2024 (1.57%), they remain below historical norms – but lender patience may finally be waning.
In 2025, twenty percent of $4.8 trillion ($957 billion) of outstanding commercial mortgages held by lenders and investors will mature, according to the Mortgage Bankers Association. Among loans backed by industrial properties, 22 percent will come due in 2025, as will 24 percent of office property loans. In recent years, lenders have allowed extensions when loans come due, but in a January report, Stav Gaon, head of securitized products research and strategy at investment firm Academy Securities, issued this dire warning: "We expect (loan) servicers to be much more inclined to appoint receivers and foreclose on properties, rather than ink another modification."
Those seeking to refinance in 2025 are unlikely to get relief from interest rate cuts. While many were encouraged by last year’s full percentage point drop in the rates, the Federal Reserve chair indicated in February that they are not “in a hurry” to resume cuts anytime soon, given that inflation stubbornly remains above their preferred target.
“It's a super interesting environment,” says Bo Hargrove, SIOR, principal with Rich Commercial Realty in Raleigh, NC. “I'm sure every single market is seeing challenges – particularly with office, but other product types are certainly not immune to this kind of financing/loan maturity situation coming down the pike. Some of it has already hit, and some of it will hit over the next few years, but when landlords are facing these loan maturities, it’s imperative that the tenant has somebody who understands how that can impact them.”
What Brokers Can Do to Protect Their Clients
For tenants occupying a property with a pending mortgage maturity and a landlord facing foreclosure, “the time to do something was when you negotiated your lease, and unless you can amend that lease, there's not a whole lot you can do,” explains Michael Feuerman, SIOR, an attorney and tenant rep broker for South Florida-based Berger Commercial Realty. “You have to approach your lease negotiations at the beginning, when you're looking at space and have a competitive advantage, with multiple landlords vying for your business. That's the time to get the protections.”
Due Diligence
Feuerman and other SIORs interviewed for this article stressed the importance of conducting thorough due diligence to fully understand the landlord’s financial position and loan mortgage status before entering into a lease. This ensures that the client is not walking into a potential foreclosure or receivership scenario.
The increasing automation of warehouse/distribution facilities, the explosive growth of power-hungry, AI driven data centers, and the electrification of just about everything are creating a massive drain on existing systems.
"The broker needs to understand who the landlord is. What is their ownership structure? Is it a fund? Is it a REIT? Where is their debt coming from? Where did their equity come from? What other specific assets do they own and hold?" advises Hargrove. "All of that paints the picture of the landlord’s financial situation, and all of that impacts how you negotiate on behalf of the tenant."
Hargrove emphasizes that knowing where the owner’s equity comes from is important because it can limit their options. For example, if the landlord raised equity through a fund in 2018 with an exit window of seven years, the fund is now closed, and the loan is maturing. “So they find themselves in a position where they have to hold the property for longer than they ever intended – which has happened a lot – and they can’t refinance because the fund is closed, and you can't just easily get more equity from the fund. They can't really sell it because of the position of the property and don't want to invest a whole bunch of dollars into an asset that's sinking, so some landlords have just given back the keys."
Bill O’Brien, SIOR, president of Brooklyn-based M. C. O'Brien, Inc., says that due diligence is an essential component in the process for any broker. “We look at the landlord’s financials and research the public records to make sure that what the (owner) has presented jives with what we can determine from the mortgage documents and reporting. It’s an extra step, but maybe 70% of the brokers don't bother doing it if they’ve got the P&L and the balance sheet from the landlord.”
Protecting Leasehold Interests with an SNDA
Brokers can protect their tenants’ interests and minimize disruptions to their business operations in the event of foreclosure by pursuing a favorable SNDA (Subordination, Non-Disturbance, and Attornment) agreement with the lender. With many lease agreements, the tenant may or may not have priority over the landlord’s mortgage, and a foreclosure sale may terminate their leasehold interest against their wishes – meaning the tenant would lose not only their leasehold interest but also the tenant improvements they completed at the property.
While an SNDA is the best protection against such a scenario, whether or not it’s attainable depends on several factors, including market conditions and the desirability of the tenant to the landlord. “If you have a tenant that the landlord really wants – that’s taking a significant percentage of the building, with very solid credit and a long-term lease – then you can work on out-of-the-box cure provisions in favor of the tenant,” says Feuerman. Those provisions may include the right for the tenant to complete any tenant improvements (TI) and to make any necessary repairs to building systems, mechanical systems, etc., during the lease term, as well as the right to pay their broker. It also includes the right to be paid back. “If the landlord doesn't have the funds to pay the tenant immediately, brokers can negotiate upfront to be able to take a rent credit against that work,” says Feuerman. “That’s an important provision, and a lot of landlords will push back on it, but if you have leverage with a very good tenant, then you can push for some of those things.”
O'Brien concurs. “It's a really interesting time to be a tenant in the market. If you’ve got a good broker and you have a good signature, you're going to be able to secure concessions beyond TI and free rent in terms of securitizing your lease that you wouldn't have been able to get in New York pre-COVID.”
Getting Creative
Stanford Scriven, SIOR, founder and principal of Northwest Tenant Group in Portland, Ore., says his firm has been able to negotiate unique protections in creative ways that most brokers haven't considered. “We only represent tenants, so our entire mindset comes from the business operator's perspective,” he explains.
Scriven says that because a tenant cannot simply stop rent payments to recoup damages, brokers need to aggressively pursue offset rights in the case of monetary or performance default (failure to reimburse TI allowance, maintain the building, etc.). In one case, Scriven secured a deal for an 8,000-square-foot medical client that included one year of free rent and operating expenses plus a $840,000 TI allowance. Since the standard offset of rent wouldn't be enforceable for 18 months (accounting for buildout and free rent period), he negotiated annual penalties of 8%, compounded monthly to compensate the tenant for the delayed access to their funds – and applied that to his commission as well.
In situations where lenders are averse to offset rights, Scriven has structured the TI allowance and free rent as interchangeable buckets, a tactic buried in the work letter and not necessarily labeled as “offset rights” – although it serves the same function. Tenants can dump money from the free rent into the TI bucket or the reverse, where unreimbursed TI can be dumped into the free rent bucket. “Because we’ve taken a unique approach to offset rights, we’ve been able to structure extremely favorable deals for our clients even when lenders are averse to the idea at first,” says Scriven.
With the impending wave of loan defaults, tenant brokers need to be willing to go the extra mile to safeguard their clients' leasehold interests. “I’ve been an SIOR for 25 years and learned how to maintain a relationship with the client by protecting them and acting in their best interests,” says O’Brien. “I know there are no guarantees in life, but I do know if you use the best practices that I've learned through SIOR as an independent broker, it brings value to every transaction.”
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
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