A prime office recapitalization that paid what the underwriting said, and the reserve sizing that made the difference
After looking at cases where an office deal went wrong, it is worth studying one that held up. In early 2023, new equity comes into a recapitalization of a newer office tower in a strong downtown submarket, built 2016, roughly 240,000 square feet, 91 percent leased, weighted average lease term a little over seven years. The prior owner needed equity to pay down a loan ahead of maturity, so new capital came in at a basis below replacement cost. What a careful investor checks before committing: the expiration schedule, where under 8 percent of rent rolled in the first three years, the reason to look twice at all. The lease structure, almost entirely net or modified gross with expense pass-throughs and annual escalations, so operating cost increases do not land entirely on ownership. The debt, fixed rate with five years remaining after the recap and DSCR comfortably above 1.3 at close, with no rate cap set to expire. And the reserve, sized at $6.1M for leasing and capital against a building where a full floor retenant modeled at about $1.9M all in, enough to cover three retenants at once. What nearly broke the deal: a tenant occupying about 11 percent of the building went into restructuring and stopped paying for five months, cutting distributions in half for two quarters while the sponsor worked the situation. The space ultimately got assigned to a larger existing tenant expanding into it at a higher rent, and the reserve covered the gap in the meantime. Without that expanding tenant already in the building, the sponsor would have faced 26,000 vacant square feet in a year when leasing was slow. Three years in, on an initial $60k position, distributions totaled about $14,200 with the position marked slightly above cost. Not a home run, but proof that an expiration check up front, a reserve sized for multiple retenants, and no unhedged floating rate exposure are worth insisting on.
