Covid-19 is affecting CRE lease negotiations. Here’s what experts are seeing.
How will Covid-19 affect the future of commercial real estate? It’s a multibillion-dollar question that’s been debated since the start of the pandemic.
With many businesses still plotting their returns to the office, the answer remains to be determined.
But experts say the effects of Covid-19 are likely to reverberate in the industry for years to come, and commercial lease negotiations — particularly those over the next year — are likely to provide some early clues about the pandemic’s effects.
Industry experts have a few ideas about what to expect. Especially in the short term, experts say it’s likely tenants will have more leverage to negotiate terms. That’s particularly true for larger tenants and those that draw other tenants or customers to a property.
One potential area of focus is specific clauses in leases that could provide protection in the event of a future pandemic.
Maria V. Bernstein, a real estate attorney at San Francisco-based SSL Law Firm LLP, expects more discussion around force majeure or unforeseen circumstances clauses in the wake of Covid-19.
As shutdowns and shifts to remote work dominated the early days of the pandemic, Bernstein said many companies rushed to review their force majeure clauses, generally finding little to no relief.
In the aftermath of the pandemic, Bernstein said it’s likely many tenants will be negotiating those clauses to create an avenue for relief in future situations like Covid-19.
She also expects companies to take a closer look at condemnation clauses and their potential role in a scenario where the government shuts down businesses or limits capacities.
Bernstein said condemnation clauses often say that if there is a “taking” by a government, then the lease is automatically terminated.
In a case where a government limits capacity to 25%, for instance, she said a good argument can be made that a government took 75% of the space, which could create leverage for potential relief.
“Everybody looked at force majeure. People looked at the environmental clause. People even looked at casualty. Those clauses helped almost no one. I’ve looked at it,” she said. “But the condemnation takings clause has given me leverage.”
When using condemnation clauses to find leverage, Bernstein said the use clause is very important.
“The narrower the better for tenants, but in negotiating leases, the broader the better,” Bernstein said. “Since we don’t have crystal balls, this is something that probably won’t change in lease negotiations, but landlords can take comfort when granting broad use rights that this may ultimately benefit them should we face future catastrophes that lead to the type of government-mandated shutdowns we have just seen.”
Tim Blair, president of Chicago-based CCIM Institute, a global commercial real estate investment education group, said he expects to see more interest in common-area-maintenance fee caps and lease structures that allow tenants to benefit from decreased maintenance costs. As we’ve noted, CAM charges are an area where landlords are seeing more scrutiny.
Blair said Covid-19 will likely accelerate the trend of triple-net leases for office buildings — something that was already becoming more common in newer buildings in larger cities.
Those arrangements allow landlords to allocate specific expenses to specific office suites. In a shutdown situation like Covid-19, that would allow tenants to benefit from an expense reduction — a benefit many tenants didn’t have during the pandemic.
Blair said he also envisions more tenants will push for being able to opt out of certain services, such as janitorial expenses, in a future scenario with offices being shut down for a long period of time.
Evelyn Ward, Houston-based vice president of agency leasing at Transwestern, envisions health and wellness amenities will be a more prevalent discussion between tenants and landlords in lease negotiations. But she’s not referring to gyms or outdoor spaces.
She said more tenants will be asking about specialized air filters, touchless amenities and fixtures and enhanced janitorial services, among other options.
“It’s a constant conversation, and it’s not a one-time thing,” Ward said. “A lot of it is because of what’s being demanded by the employee.”
She said health and wellness considerations are likely to become an expected standard like a conference room.
Ward said it will likely be a particularly heavy focus in the short term, as companies prioritize creating a safe and welcoming environment that makes it easier to bring workers back to the office.
“HR has been a part of the leasing decision forever. I think (Covid-19) just ratchets it up to another degree,” Ward said.