By Ken Ashley

ATLANTA (April 4th, 2011)

bb-king

This great BB King song must be emblematic of how some down on their luck developers feel at this point in the market. Tenants are demanding rent reduction and more services; the tax man wants to be paid; the lender is holding on the other line and oh, by the way, you need to cash a check to feed the kids. Developers take big risks and sometimes those risks don't pay off.

We empathize with some landlord friends who are currently losing at the real estate game. The economy is recovering, but life in ownership is still hard in very real and personal ways, and we know this economy can be humbling to even the biggest ego. Most landlords in 2011 would tell you that debt is like a chocolate cake: delicious in small slices, but really bad for you if you have too much.

We are becoming a whole generation of "recession babies" who view debt as anathema and important to eliminate as quickly as possible. Certainly millions of Americans are cutting up credit cards and paying with Ben Franklins instead.

Want at Toaster With That CMBS Loan?

But wait, the Wall Street Journal and other publications are suggesting that the debt markets are coming back. In this blog article in the Wall Street Journal

 

 

 

(CMBS Industry Ready to Exhale) Eliot Brown suggests that softening  of requirements on banks will allow them to more quickly issue Commercial Mortgage Backed Securities again. I feel a collective eye roll as you say, "Here we go again."

Of course, debt is a tool like any other, and it is really the oxygen that allows commercial real estate to move ahead. In this brilliant post from March 30th by Dr. Sam Chandan –  The Return of the Rise of CMBS –  which ran in the New York Post, Sam explains that "This marked (positive) shift in borrowers' access to credit has facilitated a critical mass of trades, supporting a degree of price discovery that was absent just a year ago; it has also allowed mortgage rates to remain near their cyclical lows even as long-dated treasury prices have fallen and yields have risen."

The lesson as I see it is simply "in all things, moderation." Thanks again, Ben Franklin.

Don't You Be A Loser at Leasing

While it has become a national sport to shake our heads and wag our fingers at those developers that foolishly took all that risk, there most certainly is a parallel in the tenant universe. Our friends in the technology community used to call it "leasing ahead of the curve." Some would call it leasing on a credit card. We call it not smart.

Leasing significant space in a vague anticipation of future growth can be expensive, but oh so tempting. Other tenants in the building are expanding and you might get boxed out! We need a solid path for growth, the managers proclaim. And if we sell that order of the BR549's to the Chinese, we will need to hire gaggles of people quickly!

The "get them while they are hot" philosophy should be treated with great care in an environment in which lease obligations are firm commitments for years to come. The sad fact is that real estate is likely your second largest cost. Your largest cost – payroll – can be reduced relatively quickly through terminations, although this is not pleasant. Real estate is a commitment with no easy exit as we discussed in this post from late last year.

Let's Keep Mom Happy

So, no matter the promises of future sales, business is booming and you need to hire more folks. This nonsense of working 90 hour weeks can't last. How do you not "overspend" or overcommit in real

estate? Through a beautiful thing called an option. Our advice to many clients now is to "go long and option up." Translation: lock in low rates that are prevalent in the market and preserve both your growth and contraction ability through options in the lease. Ask your real estate broker about this, and talk to the lawyers, but exploring a soft instead of a firm commitment for space can many times be a career saving approach.

Another way to handle this issue is to partner with an architecture firm and develop a firm understanding of your space usage. The document the architect produces is called a program, and it will be the basis for calculating how much space you really need in the future. When the sales guys show up with the signed order and a big smile, you can then feel good about expanding based on a detailed and empirical look at your space needs as opposed to guessing on butts in chairs. No jiving with a program.

Expansion, like debt, is certainly not in and of itself a bad thing. Just don't eat too much chocolate cake or you will be singing the blues. Moderation makes Mom happy, you know.