What commercial landlord wouldn't want to lease their entire building to one tenant? It's much easier to do that than to rent to multiple tenants. Collecting rent from and dealing with only one tenant is generally a simpler way of doing business.
But who saw the pandemic coming -- and with lockdown orders keeping people away from the office? Nothing like that has ever happened before. The result is landlords who rented an entire building to one tenant are at risk of losing that building if that tenant leaves, and that's exactly what's been happening, although not on a huge scale (at least not yet anyway).
There's good news and bad news
The good news is that most commercial leases are for multiple years. That's what's saving many commercial landlords from foreclosure. If not for long-term leases, we'd be seeing a lot of commercial building foreclosures. But the numbers aren't too bad. Only 2.2% of office buildings were delinquent in March of this year.
The bad news is that when tenants leave, the building loses value. One Houston office building that was valued at $121 million lost two big tenants and is now valued at $25 million. A valuation loss this high often results in banks becoming reluctant to refinance the mortgage, and that could lead to an owner losing the building.
An outdated outlook
Regardless of whether there are many foreclosures or not, the way commercial real estate landlords present office space, whether for one big tenant or multiple smaller tenants, might need to change moving forward. Office workers are concerned about the safety of buildings. They want proper ventilation to help prevent the spread of viruses, and they want to ensure high-touch areas are disinfected (not just cleaned). Landlords, to attract and keep tenants, need to demonstrate how the office environment will be safe and not be a virus super-spreader. Landlords who don't upgrade their buildings stand to have vacancies.
Look at the bright side
Losing a major tenant is not ideal. But landlords who deal with reality and then try to solve a problem typically fare better. One way to deal with tenant loss is to use the vacancy period to renovate the building. Landlords who believe people will return to the office are spending millions of dollars on upgrades so that their newly renovated buildings will be the one new tenants choose. Another option: Some office buildings might be converted to apartment buildings.
Lease to multiple tenants
Some commercial landlords are leasing to multiple tenants as their first action plan, which sometimes includes breaking up the space for many small tenants instead of one large tenant.
One San Francisco building, for example, got multiple small tenants in the building first, and that gave a large tenant the confidence to pick that building, ultimately renting half of it. It's a different approach than going for the large tenant first, but people are trying new things to see what works.
The Millionacres bottom line
If you invest in commercial real estate, keep in mind which buildings will be in position to pivot. Those most likely to succeed are the ones paying down the mortgage and are acquiring little debt. They can then be in a better position to refinance the mortgage, which would then provide the capital needed to reinvest in the building. It takes some planning, but commercial office space can become better and more attractive to tenants in a post-pandemic world, often with just some renovations.