There have been many articles regarding the future of the office. Pundits are speculating about its new form and whether the office will even survive the coronavirus pandemic. We suspect the office will survive in an improved form, but these passing concerns may be missing the forest for the trees.
The real revolution that may be taking place is in the relationship between landlords and tenants. Virtually all of the legal commentators have opined that the tenants who have been unable to use their offices for months due to the pandemic are still liable for the rent under those leases.
Consider the absurdity of the present situation. In what other commercial transaction are people required to pay for services that are impossible due to government order or at the very least dangerous to use? Good luck getting paid in any other business for goods and services that are not provided. Accordingly, tenants are understandably enraged. Landlords, faced with their own ongoing costs of operations, employees, taxes and debt service obligations are understandably worried and defensive. And as commercial and residential rent payments are missed, the risk to the banks and the collateralized mortgage-backed securities market will rise if present trends continue.
You have may have noticed a recent New York Times article which discussed a regional office leasing broker who was roundly criticized in the industry for offering assistance to tenants and attempting to renegotiate their leases. Our company also sent out e-mails offering similar services and were accused by one landlord of engaging in “predatory” practices. That was because we had the effrontery to represent our clients’ interests vigorously by suggesting tenants should consider seeking relief from their landlord if they could demonstrate with appropriate financial information that they could not pay their rent due to the economic crisis.
Due to the crisis, the real estate world has been turned upside down and the leverage has been totally flipped. Previously, New York City landlords in quality buildings were accustomed to sitting back and receiving over $100 per square foot for space as tenants bid up the price. Today, no tenant wants to be the first to go back to the office and they are all rethinking their plans as they evaluate their options for working remotely while wrestling with safety and liability issues. This has put shocked landlords on the back foot. Businesses do want to get back to office work in some fashion, but the question is when and how.
Further, it is becoming increasingly clear that tenants are not going to be caught flat-footed again. As a result, the terms of office leases are changing as tenants are wising up and asserting their rights. Some of the potential changes to leases are the following:
1) Tenants are demanding shorter and more flexible leases with the right to cancel. WeWork started that trend, and it will accelerate.
2) Tenants do not want to be locked into unrealistically high future rents in the out years on their leases. Accordingly, there is much discussion about pegging rents to a market basket of rents in comparable buildings via a formula such as an average. Obviously, should rents rise that will be a function of a stronger economy, but with a formula tenants will be protected on the downside if the recession persists.
3) Percentage rent based upon transparent metrics (sometimes used in retail) may now be incorporated into office leases.
4) Reset provisions offering lower rents if the market changes after a fixed period of time.
5) Protection or insurance for tenants in the event of a pandemic or other natural disaster so that they do not have to pay rent.
Ruth Colp-Haber is president and CEO of Wharton Property Advisors