Real Deals

Times put focus on landlords' health

Tenants want to know building owners' finances are solid

Staff WriterMarch 4, 2010 

When Sunstates Security's owners began searching for a larger office space last year, they sought out a landlord that would be able to meet their immediate and long-term needs.

"We needed a company that would be flexible to our further anticipated growth," said Kathryn Burrell, who owns the company with her husband, Glenn.

Sunstates also needed an office with a training center for its corporate security guards. After shopping around, the Burrells decided to lease 5,000 square feet in West Raleigh from Highwoods Properties, which paid for their office to be fitted with a training center.

"We hope to remain within the Highwoods group for many years," Kathryn Burrell said.

As the economic downturn has squeezed more and more commercial property owners, increasing attention is being paid to the financial health of landlords.

"One of our biggest challenges right now in representing companies is making sure we work with landlords who have the money to build out thespaces," said John Stubbs, a broker at Jones Lang LaSalle, who represents tenants in the Triangle.

Brokers and tenants today want to be sure that a landlord is financially secure enough to fund the cost of the deal. That includes any money promised to improve a space, commissions for the brokers behind the deal, and money to continue to maintain the building through the term of the lease.

That a landlord's financial health has become a key factor in inking dealsreflects just how much uncertainty continues to hang over the commercial real estate industry.

There remains real concern about building owners that may be in danger of going into default because they bought property at the peak of the market with the expectation that rental rates and property values would keep going up.

Jeff Sheehan, a senior vice president at Duke Realty in Morrisville, said the situation is the opposite of what it was like during the boom years.

"Through 2004, 2005 and 2006, people would just sort of gloss over when you talked to them about your financial strength because everybody had capital," Sheehan said.

Now real estate investment trusts such as Duke and Highwoods are touting their financial strength at every opportunity. As publicly traded companies, Duke and Highwoods have the ability to raise money on Wall Street by selling more shares or issuing new debt.

Duke, for example, issued $500 million in new debt in August that is being used to pay down maturing debt.

Raleigh-based Highwoods is in a particularly enviable position, having strengthened its balance sheet by selling hundreds of millions of dollars worth of office and industrial assets since January 2005.

The company is flexing its financial muscle by offering to escrow money for tenant improvements for some prospects and touting a program that expedites the payment of broker commissions.

Landlords that are in the best position are those that are either debt-free or do not have large amounts of debt coming due soon.

"When you're in a good position with cash flow and you also have low debt, the problems are not that great," said Bret Muller, an associate partner with Capital Associates, a private real estate company in Cary.

Muller said Capital Associates avoided serious trouble by not getting involved in highly leveraged deals and passing on deals when the asking price seemed too steep.

The company signed 71 new lease agreements in the fourth quarter resulting in positive net absorption of 317,000 square feet, meaning more companies moved into that amount of its space than moved out.

"We're not doing the best deals we've ever done. No one is," Muller said. "What we're fortunate enough to have is pure Class A product. It's a flight to quality."

The office vacancy rate in the Triangle was 17.2 percent in the fourth quarter, up from 14.5 percent in same quarter the previous year, according to Karnes Research, a Raleigh firm that tracks commercial real estate trends.

With all that empty space, tenants are shopping around, and landlords that can't spend money getting a tenant into a building are at a serious disadvantage.

"Any tenant looking at the market right now is going to find multiple opportunities of vacancy," said Don Shupe, vice president of asset services in CB Richard Ellis' Raleigh office. "And most of those landlords are going to be willing to spend some dollars to make their space work for that tenant."

Building and maintaining large multiple-tenant office buildings has always been an extremely capital intensive business with long-term returns. During the boom years, when capital was cheap and plentiful, more noninstitutional investors got involved in owning and managing the assets.

The question many people are now asking is what the competitive landscape will look like now that the era of easy credit is over.

Duke Realty's Sheehan is among those expecting a shakeout.

"I think we're going to have fewer competitors," he said. "I think we're back to a more normal capital cycle." or 919-829-4548

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