What Happens When Office Landlords Go Bankrupt? And What Goes Wrong

In this article, you'll learn:

• The impact of $2.75 trillion in expiring commercial mortgages by 2027.
• The fallout from landlord bankruptcies on tenants and the market.
• Essential lease protections, including SNDA clauses, for tenants.
• Future risks in the office market and strategies for tenants.

This last year represented a massive turning point for the office market. Because amidst the downturn since 2020, plummeting property valuations have put landlords in a tailspin. Now widespread defaults are upon us as landlords struggle to fill their spaces for the same ROI.

However, the true ramifications of this switch are truly only beginning to be felt because most of the loans signed pre-pandemic are only now coming due.

In fact, experts are calling the sheer volume of expiring loans upon us a tidal wave. All said and done, by 2027, a staggering $2.75 trillion worth of commercial mortgages are set to mature.

And at this angle, we’re all standing on the shore, getting splashed by the rising water, before getting knocked down by its full force. In general, defaults can come with a lot of messiness for the landlord, tenant, and lender involved. Now multiply this by a scale of hundred-million and you’ll have an idea of the chaos we may be in for.

So, let’s talk about the scope of loans we’re dealing with and examine what happens when an individual building owner goes into bankruptcy, from the investor’s possible actions to how tenants can get caught in between.

For a more in-depth exploration into why landlords are defaulting and what you can do to protect yourself from the fallout, check out the must-have handbook, Surviving the Office Apocalypse. Get your free copy today.

CMBS Loans Expiring

This year alone, an estimated $528.7 billion of commercial mortgages are maturing, with projections indicating a further increase to $532.8 billion next year, according to data from Trepp.

And loan maturations can have a wide array of implications for every party involved. The landlord often declares bankruptcy, the lender usually assumes the active leases, and tenants can get tangled in the crossfire between banks and landlords. There’s a lot of room in this situation for things to get wrong.

So, let’s put a face to one of these defaults and explore the nitty-gritty behind the reality of when a commercial landlord goes bankrupt.

Lender Sues Connecticut Landlord

Back in 2015, Aaron Berger and a group of investors purchased a Hartford, Connecticut, office complex, including the building at 100 Constitution Plaza. The 217,000-square-foot, Class A office building has 18 floors and occupies nearly 7 acres in the heart of downtown. Berger personally guaranteed the $10 million loan from Trawler Capital Management.

And what happened when May came around? Berger defaulted on the loan triggering bankruptcy for the limited liability company that borrowed the mezzanine funds. So now the investment firm that backed the office is suing.

Now, if the landlord can’t pay the bills and the investment firm is suing, what do you think the state of the upkeep and maintenance is in the building? Well, a large-scale sublease within the building has been released. Which brings questions about the quality for tenants to mind.

Now, this is a unique case, but the point is, that there’s a lot of room for conflict when a landlord defaults, and that’s why tenants need to secure water-tight protections in their leases.

Effect on Tenants and Lease Protections

When your landlord enters foreclosure or default, ideally, it shouldn’t change the clauses you follow in your lease. In a perfect world, the lender would adopt and observe the lease to the letter it was written.

Now, lenders or banks are unlikely to kick out existing tenants. But let’s say that they want clean house for renovations or bringing in larger tenants, the attornment provision in an SNDA prevents this.

So, the SNDA is critical to negotiate in any lease. Because without its protections, you’ll be vulnerable to legal crossfire and state regulations. In some states, if the lease was signed after the mortgage, the lender can void the agreement, much to the tenant’s dismay.

Read more about why you want an SNDA in your lease. 

However, even if you have a good SNDA clause, you’re not off the hook. If the lender assumes the lease, don’t be surprised when this interruption in ownership leads to a disruption in the maintenance of services and upkeep in your leased portion of the building.

Because once the building is in receivership, the receiver’s first responsibilities are to pay the property taxes and the mortgage. All other bills are secondary. Therefore, you can expect a drop in services in a building that is in receivership. 

If this occurs, who pays? Unfortunately, if you want to maintain a habitable working environment for employees, the burden may be on you as a tenant to continue the space’s upkeep.

The solution involves the tenant having a "right of offset." This allows the tenant to reduce their rent payments by any expenses they incur due to the landlord's neglect of maintenance duties. Including this provision in your lease agreement safeguards you, the corporate tenant, even if a receiver is appointed.

The receiver is obligated to honor the lease terms. Without this clause, you lack a legal basis to offset such costs against your rent, potentially leading to situations where you might pay for extra cleaning services while still covering the full rent amount.

So, while this won’t be necessary in the case of every lease, it is one to include. Because why would you want to take chances, when landlords are at a one-in-three chance of default. It may be a more pressing reality than you think…

CMBS Loans Looming Over the Office Market 

Over the next five years, about 500 million square feet of net rentable area (NRA) in office and mixed-use properties, backed by CMBS loans on the verge of expiration.

In 2024 alone, 112 million square feet of office space are due to expire, and an additional 105 million square feet are set to expire in 2025. This adds up to a substantial near-term rollover risk of 217 million square feet.

So, when those loans are up, landlords who can’t pay them will likely go into bankruptcy. Considering the discussion above, there’s quite a lot of complications on the verge for the CRE world. With all these new considerations, tenants must navigate the office market with a different, more acute strategy.

It's crucial for tenants to exercise caution and be mindful of the potential downside—the looming risk of landlord delinquency. The uncertainty in the market and the challenges faced by landlords introduce a level of risk for tenants.

It's essential to strike a balance between seizing the current opportunities and staying vigilant about the potential risks associated with the evolving dynamics of the real estate landscape. Because other than getting caught in the middle of a nasty lawsuit, you may experience a drop in services- that is, if your lease isn't contested to begin with.

But the truth is, that this discussion is only the tip of the iceberg when it comes to navigating this new office market. To fully arm yourself with the knowledge and strategies you need to thrive, we've compiled a comprehensive guide, Surviving the Office Apocalypse. 

Equip yourself with the insights and tactics necessary to navigate this terrain with confidence and efficiency.

Don't miss out on this opportunity to enhance your knowledge and position your business for success. Receive exclusive first access now.