How can landlords and tenants work together to find a solution for tenants whose office space requirements have reduced following COVID-19?
Due to COVID-19, tenants are approaching landlords to request rent free periods, rent reductions and to delay the date when their rent falls due.
We expect that this trend will continue in the coming weeks. Looking further ahead, we believe that tenants will review their office space requirements following a contraction in their businesses which may have resulted in redundancies. More businesses may also adopt flexible home working policies if the enforced home working period has been successful, which, in turn will reduce the office space a tenant requires.
Where a tenant’s lease is nearing expiry or a break date, it is open to the tenant to move to more suitable office premises. If landlords wish to retain these tenants, they will need to think creatively about how to balance their income requirements with the tenants changing needs. They might look to reducing the space let to the tenant; look to a turnover rent model; offer lower rents; provide cash incentives to tenants; offer more rent free period; or build in more tenant breaks. Tenants may be keen to work with landlords to find a solution so as to avoid unnecessary moving costs.
In a buoyant market, tenants usually have the option of disposing of their lease by assigning it to another occupier. In a downturn market, that option is, for the most part, off the table. For similar reasons, tenants might find it tricky to sublet the whole or any part of their space.
The last option open to tenants is to approach the landlord to surrender their lease. We suspect that landlords may be reluctant to agree potentially surrender the whole of the lease. Landlords will be concerned about any rental voids since the re-letting of the unit is likely to be difficult.
That being said, it may be in the best interest of the landlord and tenant to agree to a surrender of part of the lease, provided that it is practicable to split the premises into parts.
From the tenant’s perspective, they can reduce their office space and their overheads. From the landlord’s perspective, they can ensure that the tenant is better able to meet their rental liability without the risk of the tenant falling into arrears or suffering insolvency.
We would suggest that there are various sweeteners open to landlords in negotiating the surrender of part of the lease. For example:
- landlords could use the opportunity to lock the tenants in for a longer term;
- if there is a break clause, the landlord could ask that this is removed from the lease;
- the landlord could ask for a greater rent per square foot; and/or
- the landlord could ask for a surrender premium.
The surrender premium could partially tide the landlord over until such date as it believes that they will be able to re-let that part of the unit which has been surrendered to them.
Landlords will need to think carefully about the impact that this will have on any financing they have in place and how best to protect their investment value. It may be, that they need the consent of their lender to this arrangement. Landlords will also need to be careful not to put themselves into breach of the financial covenants in their loans.
Where tenants have FRI leases, landlords may need to consider the practical implications of accepting a surrender of part of the lease. Is the landlord prepared to assume responsibility for insuring and repairing the structural and external parts of the building?
It will be interesting to see whether there is a shift post COVID-19 in how tenants occupy space.
This article first appeared in CoStar on 7 April 2020.