Tuesday 19 December 2023

Lendlease Global Commercial REIT Strange Restructuring of Major Office Lease To Reduce Tenant Concentration Risk.

This is really weird and funny. Lendlease Global Commercial REIT ("LREIT") announced on 18th December 2023 that it will be restructuring its long term Milan office lease of Sky Complex with Sky Italia in order to "reduce tenant concentration risk".  I find the header of the announcement extremely misleading and giving the impression that LREIT is the party which decided to review and downsize the major tenant, Sky Italia, on its own initiative. There are many ways to reduce tenant concentration risk such as embarking on future M&A to further reduce the impact of Sky Italia as a major tenant. Chasing after existing tenant to vacate office by a landlord to "reduce tenant concentration risk" when the lease has not expired is virtually unheard of in the market. The only plausible explanation is that the tenant must have approached the management of LREIT to re-negotiate a package deal for reduced footprint since the tenant does indeed hold an option to pre-terminate the lease (till 2032) over the entire Sky Complex in 2026.   
1. Negative impact of upcoming partial exit of major tenant on LREIT
As alluded to the above, a tenant wanting to cut space is bad news for any landlord. It also signalled that there maybe something wrong with the macro-economic environment. The vacancy rate for office real estate in Milan, Italy, varied greatly depending across different city areas from 4% to 16% based on Statista.com. Since Sky Complex is outside the CBD, it may be experiencing a higher vacancy rate issue and will take some time to fill up Building 3 which will be returned to LREIT. 
2. Good news that major tenant, Sky Italia, will compensate LREIT on 2 years worth of rental for Building 3 on top of reinstatement cost.
But not all is bad on the restructuring of the Sky Complex lease. The tenant, Sky Italia, will provide a consideration to LREIT of an amount equivalent to approximately two years of existing annual rent of Building 3 after its reinstatement in 1st quarter of 2024. 

This 2 years of compensation is a critical life line as well as creates much needed breathing space for LREIT while its leasing agents in Milan work on getting new tenants to gradually fill up all the vacant space albeit the possibly weak office commercial market. Any immediate filling up of space will be a bonus to LREIT.
Parting thoughts
Overall, I thought that the deal is a win-win for both LREIT and its tenant, Sky Italia. However, it does worry me on the financial status of Sky Italia since it decided to give up on one building to cut cost. Things may not be as rosy as it seems on the surface and fellow investors may want to closely monitor further developments in Milan. 

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