How a Building Sale Affects Lease Negotiations

The pace of investment sale activity in San Francisco is accelerating.  This is the “Great Reset” about which we’ve written.  It’s driven by capital partners (equity/lenders) deciding there is no viable pathway to own their way to an exit and choosing to sell (usually at a steep discount to what they paid and/or the value of the debt).  Ultimately, these capital stack resets are healthy as they activate the asset, enabling new capital partners to transact at market.

But negotiating a lease during a sale process can be challenging.  The process of selling an office building is about telling a story.  The story is part current reality, and part aspirational outcomes.  Sell-side brokers create the story.  They produce a beautiful book, full of data and images called an Offering Memorandum, or “OM”.  The OM is distributed to prospective buyers.  OMs include detailed data about in-place cash flow, rents, and operating costs.  They highlight the building’s features and make a case as to how the building fits into the market and submarket in which it is located.  The best marketing campaigns are augmented by credible leasing brokers who provide additional first-hand market details that support the value thesis.  Of course, buyers must develop their opinion of value and they often bring in their own leasing experts to provide detailed analysis.  When the building first comes to market, existing capital partners will not be inclined to do leasing transactions unless such transaction(s) readily support the narrative being promoted in the OM.  Imagine how detrimental it would be to the value to execute a lease that creates a worse outcome than is being represented in the OM.  When buyers can choose between the glossy pages of the OM or actual leasing activity, they know where to look.

When a buyer has been identified and the sale is “in contract” but not yet closed, the buyer will take a seat at the negotiating table and drive decisions.  After all, they will soon own the building and the lease will impact their value.  At this point, a leasing transaction should proceed at a normal pace.   

It’s important to understand when a building is trading, to know where the process stands and to properly underwrite potential outcomes.  This can be especially challenging for tenants when looking to renew a lease in a trading building.  All of this accentuates the need for broker advisors to be fully aware of the capital market dynamic, in addition to understanding the leasing market.  These days, you can’t understand one without the other.