The three years before COVID – before quarantine, before wide-spread work from home policies – represented the peak of the leasing market for many sectors. The three years since the outbreak of COVID have seen that market change significantly. As the leases signed right before COVID begin to expire and come up for renewal, tenants and landlords should be aware of the state of the market before beginning negotiations with one another.
In the years leading up to 2020, the office leases I helped clients negotiate were more likely to favor the landlord due to outsize tenant demand, but that’s no longer the case. Tenants are able to demand shorter terms, greater ability to downsize into smaller footprints, and other concessions.
For office owners, shorter lease terms might not be the worst thing in the world, as it could make financing easier in the long run. By negotiating shorter lease terms now, landlords may avoid locking in tenant-friendly rent for years to come and keep open the option that when the shorter terms expire the market has rebounded and they can refinance on better terms.
For office tenants, they should make sure there is a subordination, non-disturbance, and attornment agreement signed and recorded. If that is not in place, the landlord’s lender will have an easier time terminating the lease in the event market conditions force a foreclosure.
In contrast to office landlords, landlords in the industrial market have a great deal of leverage, as demand remains high and supply is low. Mike Ogasapian, Vice-President with R.W. Holmes Commercial Real Estate, notes that existing industrial tenants, “are faced with few market options to relocate to and landlords know that. Expansion need also is common right now among users.” Meaning tenants face a lot of uncertainty as to whether it is smarter to remain in their current premises or seek larger space. “In many instances,” Ogasapian continues, “tenants have leverage through holdover provisions that are at 200% of their current rent, which is typically 50%-70% of what current market rents are. If the tenant’s provision does not have them responsible for damages caused due to holding over, we’ve seen several users either holdover to stall to relocate or simply leverage the situation to achieve more favorable terms to remain in place.”
For industrial landlords in the current market, “holdover is the most glaring item they need to consider,” per Ogasapian. They should review their leases to double check the holdover language and negotiate with tenants with that in mind. In any amendments or new leases, landlords should ensure that a holding over tenant is liable for damages caused by that holdover.
In their amendments and new leases, industrial tenants should pay close attention to renewal language for valuation of fair market rent. It should be specific to their asset type and geography. With lots of new construction in greater Boston and strong demand for industrial space throughout the region, Ogasapian says that for industrial spaces, “the renewal provision should reflect that the valuation take into account lease comps for area buildings not only of a similar type, but year built as well.”
Going into the COVID era, lab space tenants frequently leased more space than they needed at signing, with the expectation that they would need it as they grew, and they would grow quickly. However, that has led to problems in the current market. Ogasapian says that for “lab/R&D tenants, economic market conditions have deferred expansion needs and, in many cases, caused users to put a portion of their space on the sublease market.” In some cases, nearly half a property’s square footage is up for sublease.
In amendments and new leases, Ogasapian recommends that lab landlords “focus on tenant credit and annual increases in any new lease or renewal” as the rental rate over the term will typically be “a function of the improvement costs.”
Given the issues lab tenants are facing, they should look carefully at their lease terms governing subleases, particularly how they share profits with the landlord. Per Ogasapian, lab tenants “that look to sublease will typically build out entire premises and set aside a position of that as a mix of furnished and built lab with some office. The rental rate typically does not include any furniture, fixtures, and equipment and therefore should be accounted for as reasonable transaction costs not to be shared as profit.”