Steering Through Uncertainty: The Commercial Tenant's Guide to Property Foreclosure

A man walking through an empty building. June 25, 2024 By: Mindy W. Saffer

Associations that lease their office space should be aware of the situations that can arise if their building owner defaults on their loan. Here’s how to get in front of and address common concerns. ​

The landscape of commercial real estate is fraught with potential economic tremors, one of which is the foreclosure of a property due to the owner's loan default.

The stability of your association’s office space can be vulnerable in these circumstances, leading to operational disruptions and financial complications. To mitigate these risks, understanding your lease's intricacies and the implication of foreclosure is paramount. This article will look at the essential role of “Subordination, Non-Disturbance, and Attornment” (SNDA) agreements, while also addressing common concerns related to the foreclosure process.

Understanding Your Position and the Role of SNDA

Review your lease agreement. An SNDA is a critical component that affects a tenant's security in foreclosure scenarios. It serves three main functions:

  • Subordination. This part of the SNDA means that the tenant agrees to allow their lease to be subordinate to the mortgage on the property. This is typically a benefit to the lender because it ensures that the lender’s mortgage interest comes before the tenant’s leasehold interest in the property.
  • Non-Disturbance. This provision is particularly beneficial to the tenant. It assures the tenant that their lease and possession of the property will not be disturbed if the property is foreclosed upon, and the lender takes over ownership. In other words, it provides stability and security to tenants, guaranteeing that they can continue to use the property under the terms of the lease despite any changes in property ownership.
  • Attornment. This clause requires the tenant to recognize the new owner of the property as their landlord should a foreclosure occur. For the lender or any future property owner, this is beneficial as it means that the tenant will continue to pay rent and perform all the obligations stated in the lease, even after a change in the property's ownership.

The benefit of an SNDA is that it creates a safety net for tenants, ensuring continuity of their lease terms regardless of ownership changes. However, securing an SNDA can vary in difficulty. In a strong market where tenants have leverage, landlords may be more amenable to include SNDAs to attract and retain tenants. However, in a landlord's market, or when dealing with lenders with stringent policies, it can be more challenging. Your real estate consultant must introduce this language in the Letter of intent while your legal counsel is indispensable in negotiating these terms effectively within a lease. Legal expertise can also illuminate your rights and obligations, especially in understanding the complexities of SNDAs and how they function within the broader scope of tenant-landlord laws.

Preparing for Change

If your office property is transferred to a lender, change is likely. Here’s how to best navigate those circumstances:

  • Communicate with the lender. Should the building be transferred to a lender, proactive engagement is crucial. Lenders might not have the infrastructure to manage property and are often open to dialogue to ensure a seamless transition.
  • Know the lender's rights without an SNDA. If you lack an SNDA and the building is reclaimed by the lender, the risk of eviction increases. While some lenders may choose to honor existing leases to maintain the income stream, without an SNDA, there is no legal obligation to do so, and tenants could potentially be removed.
    To understand your risk, ask your real estate consultant to check if you are currently paying above or below market. If you are paying below market, you are at a higher risk. Also, ask your real estate consultant to tell you the vacancy of the building. If you are one of the only tenants left in the building, you are also at risk because the building may be sold to a redeveloper changing the use from office to residential/educational/hotel or other.
  • Understand the new lender's obligations regarding SNDA. If an SNDA was in place with the previous landlord and their lender, a new lender who takes over the property is typically bound by that agreement. However, this depends on the specific terms outlined in the SNDA and the nature of the foreclosure proceedings. This question can be answered by your real estate attorney.
  • Finally, if you want to terminate your lease, you may have an opportunity to negotiate a termination with the lender so again, proactively evaluating all options is recommended.

Mitigating Risks

To avoid potential issues, be proactive and take the following steps:

  • Monitor the foreclosure process and market trends. Awareness of the procedural timeline and market dynamics is vital. Speaking to the Washington, DC, metro market, data on buildings that went into receivership reflects market trends: While numbers for 2020-2023 are specific and would require up-to-date regional market analysis, typically, foreclosure rates can indicate the health of the real estate market. An uptick in foreclosures may present renegotiation opportunities or signal a need for tenants to develop exit strategies.
  • Have a backup plan. With or without an SNDA, a solid contingency plan for alternative office spaces is prudent.

In addition, keep in mind these longer-term strategies:

  • Lease considerations amidst uncertainty. Assess the viability of renewing leases in unstable situations. Even with an SNDA, evaluate the merits of remaining in a building likely to experience ownership changes.
  • Leverage market conditions. Should foreclosure result in a change of ownership, knowledgeable tenants can often negotiate favorable terms by understanding the local real estate climate and using it to their advantage.

Navigating a building owner's foreclosure requires a nuanced understanding of lease agreements, particularly the protective mechanisms of SNDAs and the ability to proactively engage with lenders. No matter where your association is located, keeping abreast of market and foreclosure trends can inform strategic decisions. Commercial office tenants must remain vigilant, informed, and ready to act to ensure their business's resilience in the face of property ownership instability. Legal counsel remains an invaluable ally in these situations, providing clarity and advocacy to safeguard tenants' rights and interests.

Mindy W. Saffer

Mindy W. Saffer, LEED AP, is a managing principal at Cresa, a commercial real estate company in Washington, DC.