OWN a building and collect recurrent income from legally binding agreements. Sounds easy.

However, things have been rocky for landlords in recent times. Lockdowns and movement restrictions to fight the Covid pandemic have brought into question the relevance of properties such as office buildings, and resulted in landlords extending help to tenants across various property types.

In 2022, inflation started flaring and the US Federal Reserve began hiking interest rates aggressively. Many landlords are hurt by rising costs eroding operating margins. Many property owners are also facing higher borrowing costs and credit tightening.

Might recent news of woes at the likes of Credit Suisse Group and Cyxtera Technologies signal greater turbulence ahead for landlords?

Investors may need to worry more over the creditworthiness of various tenants of property groups.

Credit Suisse

Rocked by various scandals and loss of confidence among customers, banking giant Credit Suisse teetered. To ensure financial stability, Swiss authorities engineered a deal in March for UBS Group to buy Credit Suisse – supported by billions in state funding.

There is significant overlap in the operations of the two banks. Press reports said the enlarged UBS is set to reduce its workforce by up to 30 per cent.

As staff in the financial services sector fret, so should office landlords in major cities, including Singapore. Will anchor tenant Credit Suisse give up space at Grade A office building One Raffles Link in the Marina Bay area, which is owned by Hongkong Land : H78 +2.28%?

Given that Singapore is a major financial centre, weakness in the financial sector could hit jobs and office landlords here hard. 

CapitaLand Integrated Commercial Trust : C38U -0.49% (CICT) owns a diversified portfolio that includes several office buildings in the central area. Last year, financial services was the top sector for new leases signed at CICT’s Singapore office properties, accounting for about 36 per cent by net lettable area.

While office landlords worry over whether more tenants in key sectors such as financial services and technology may give up space, jitters over the financial health of tenants are being felt in other property segments too.

Cyxtera Technologies

The initial public offering (IPO) in December 2021 of pure-play data centre real estate investment trust (Reit) Digital Core Reit : DCRU 0% was about 19.4 times subscribed.

On its trading debut, Digital Core Reit closed almost 15 per cent above its IPO price. Today, the Reit, which owns data centres in the US, Canada and Germany, trades way below its IPO price.

Demand drivers for data centres look strong amid digital transformation across many businesses. And vacancy rates are generally low in the markets where Digital Core Reit’s data centres are located. 

But investors are nervous over the financial health of what is understood to be Digital Core Reit’s second-largest tenant – Nasdaq-listed Cyxtera Technologies. Concerns surfaced over the global colocation data centre operator’s ability to service its debt obligations.

Cyxtera accounts for about 22.6 per cent of Digital Core Reit’s annualised rental income. In-mid February, Moody’s Investor Service downgraded Cyxtera’s corporate family rating.

Digital Core Reit’s manager said on Mar 20 that its second-largest customer remains current on its rental obligations and has not requested any rent deferments, rental reductions or contraction of the space it occupies.

Still, might Cyxtera face problems meeting its rental obligations? For 2022, Cyxtera reported a loss of US$355 million.

The results announcement shows that the company has US$96 million of short-term debt which expires this year, and US$853 million in long-term debt that matures in 2024. As at end-March, Cyxtera’s share price fell over 90 per cent from a year ago.

In H1 2022, Digital Core Reit was hit by a customer bankruptcy. The Reit’s manager said in its latest annual report that it is cautiously optimistic on backfilling the affected capacity with no impact to distribution per unit.

Reasons cited are favourable data centre fundamentals, the strength of the sponsor’s global platform and cash flow support by the sponsor. 

Digital Core Reit’s unit price as at end-March is down by about 27 per cent from end-February and around 60 per cent from a year ago.

Mitigation

Nonetheless, investors should not get too fretful over big tenants not meeting rental obligations because of business problems.

Landlords enjoy some protection from the risk posed by troubled tenants. For example, landlords typically hold deposits that are paid upfront upon the signing of a lease. 

Should a tenant go belly up and stop paying rent, the rental deposit can perhaps help a landlord tide over for a few months while searching for a replacement tenant.

If a failing business gets rescued, the new owner generally takes over the existing lease obligations. Maybe the new owner will seek to give up some space that has been leased, but this will likely be subject to negotiations with the landlord.

In a tough economic environment, more questions can arise over the creditworthiness of various businesses.

Many landlords will be anxiously hoping that their tenants do not hit news headlines because of financial woes. 

Likely, the larger landlords with reduced single-tenant concentration can cope with headwinds. Market leader CICT has a diversified trade mix from a total of about 3,080 tenants in its portfolio. 

CICT’s latest annual report showed that no single tenant contributed above 5 per cent of gross rental income. Collectively, the top 10 tenants accounted for 19.8 per cent of total gross rent.

With worsening economic and credit conditions, landlords should prepare to deal with more tenants that may give up space or be tardy in rental payments. Ultimately, what matters is whether space that is given up can be filled up quickly and at good rates. 

Some landlords may see a silver lining, should space that is vacated be filled up at a higher rental rate. A mall owner may be glad to see an underperforming anchor tenant – who pays relatively low rent – terminate its lease early, so the occupied space can be reconfigured for more productive use.

In what will be a tougher leasing environment, landlords need to have strong products as well as asset management and leasing teams to survive.