The paralysis that surrounded commercial leasing early this year has given way to a pronounced uptick in activity. The demise of 2009’s doldrums isn’t good news across Greater Boston, though. Revived leasing activity has the potential to widen the gap between leveraged and well-capitalized landlords.

Industry players fear that tenant improvement requirements will place new financial strain on property owners, who are already being battered by falling rents and vacancy rates. In some cases, owners will be forced to borrow the capital to allow a deal to happen. In others, tenants will walk away from a potentially troubled owner, seeking refuge with deep-pocketed landlord – and exacerbating the former owner’s troubles. Some are even predicting that leasing transactions, not loan maturities, will be the impetus for a flood of distressed asset sales.

John Conley, senior vice president for asset management at Equity Office Properties, said at a recent industry roundtable that Equity expects to do a greater volume of deals this year than the firm did in 2007.

“We were very busy this summer,” he said. Tenants have taken advantage of depressed rents to upgrade the quality of their office space. “Tenants are looking for value and trading up, and we benefit from that,” Conley argued.

Not everyone may be benefiting, though. Lease transactions make capital demands of landlords. The higher a landlord’s basis is, the more vulnerable that developer is to dramatic swings in income. Asking rates in greater Boston Class A properties have fallen 20 percent over the past year.

Tenant Brokers’ Lack Of Confidence

As landlords’ capital cushions grow thinner, they’re less and less able to put up the tenant improvement dollars that deals require. One of the problems Broadway Partners ran into in the John Hancock Tower was that tenant brokers had no confidence that the investment firm had the financial wherewithal, or the backing of their mezzanine partners, to get vacant space into useable shape. Brian McKenzie, a broker with Richards Barry Joyce & Partners, warned recently that “many landlords may soon be unable to provide TI.”

Brian Kavoogian, president of Charles River Realty Investors, said at a recent industry roundtable that his firm is looking at investment opportunities through outright purchases, recapitalization participation, and tenant improvement lending.

“There will be capital needed, to deal with over-leveraged properties and with TI,” he said. “As leasing picks up, [landlords] will need capital. I don’t see the lending community putting up capital for TI or leasing commissions.”

In the aftermath of the Blackstone Group’s peak-market acquisition of Equity Office, the buyout firm held assets in the country’s core markets, but quickly spun off Equity properties in less prominent markets. That maneuvering didn’t just produce a tidy return for Blackstone. It also allowed the firm to lower its leverage, freeing up cash for a series of capital improvement projects, including several lobby renovation projects aimed at drawing new tenants and creating new value.

Here Comes The Flood

“We’re in much better shape than if Blackstone had kept every single building and went to 90 percent leverage,” Conley said. “That set us up for the future.” The firm’s current strategy, Conley said, is, “let’s improve buildings, fill them up with credit tenants, and weather the storm.”

Not every investor is in that position, though. In a recent earnings call, an analyst asked Boston Properties President Douglas Linde about the likelihood of the giant REIT scooping up properties felled by mortgage maturities. Linde replied that “while maturities are certainly an obvious friction point, leasing transactions may force earlier action.” Linde said leasing-driven capital needs will cause some investors to come to terms with their tenuous positions long before their mortgages come due, forcing distressed properties to market.

“I think maturities are not going to be the driver,” he argued. “I think it’s going to be frictional transactional activity that’s going to get that stuff unglued sooner, rather than later. Because as assets have capital requirements or leasing requirements that are necessary, those parties are going to have no choice but to get together and start to realize what situation they might be in, and that’s going to cause an action.”