The Evolution of Lease Negotiation

COVID-19 changed just about everything, the way we shop, socialize, travel and work.  In many instances, the changes are readily discernible and quite dramatic.  Think of Broadway going dark, and Times Square being virtually deserted.

Other changes will be more subtle, emerging almost imperceptibly over a protracted period of time.  For example, the manner in which leases are negotiated is going to evolve.  Look for these changes to impact new leases, extensions, as well as negotiations to restructure existing leases.

Digitization

COVID has accelerated the migration towards digitization in scores of industries.  Many sophisticated landlords and tenants had already adopted software products to make drafting, negotiating and revising lease documents more efficient.  Expect this trend to pick up steam.

Merit-Based Lease Negotiation Will Become Increasingly Popular

Real estate negotiations have a tendency to emphasize two prominent styles, hard and soft.  Hard negotiators tend to value results over relationships.  Conversely, soft negotiators attach great importance to relationships and are predisposed to agree to unmerited concessions, incorrectly believing that these sacrifices will improve the relationship.

COVID has underscored the interdependence of landlords and tenants.  With such interdependence having been highlighted, parties will increasingly resort to merit-based negotiation.  This model emphasizes keystones such as reliance on objective criteria, the development of BATNA (Best Available Alternative to a Negotiated Agreement), satisfying your interests as well as those of your counterparty, attacking the problem not the people and trading items of unequal value.

Lease Negotiations Will Increasingly be Predicated on Objective Criteria

Objective criteria are benchmarks, barometers which can be instrumental in first narrowing and then bridging gaps that divide the parties.  With the proliferation of readily available quality information, the quantity and quality of objective criteria will continue to increase.  Rather than resorting to the use of force, the parties will negotiate over which criteria to apply.  By focusing on interests and standards, negotiators can confront problems collectively, producing more effective solutions.

Following their successful application during lease negotiations, objective criteria will increasingly find their way into lease agreements, embedding themselves there.

Flexibility

Tenants’ pursuit of flexibility can take many forms.  Due to COVID, office tenants have been required to remit rent for space they either couldn’t use or couldn’t use as contemplated in lease agreements.  Moreover, remote work has emerged as a viable option for at least part of the workforce, at least part of the time.  As a result of these and other factors, office tenants will be more prone to pursue increased flexibility.  Such flexibility can take many forms including early termination rights and the ability to increase or diminish the size of the leased premises.

Tenants will become progressively more reluctant to lease a set amount of space for a protracted period of time.  The longer the lease, the greater the risks, including the risk that the tenant will either outgrow the space or that it will be larger than required.  Tenants are aware of such risks, and seek to manage them when negotiating terms, including monetary terms.  There is a more efficient means of managing the risk, hence the trend towards increased flexibility and the permanent addition of temporary/flex space as an amenity in class A office buildings.

Landlords will adapt to such trends, ultimately benefiting from the ability to impose higher rates for tailoring lease provisions to tenant needs.  Flexibility will be accompanied by customization, for example landlord commitment to satisfy short-term tenant needs.  In this way, landlords will be able to charge premium pricing for satisfying occasional spikes in demand, while tenants benefit from being able to tailor the consumption of space to actual needs.  Premium priced flex space will ultimately be a more fiscally prudent investment than recurring rent on superfluous “permanent” space.

The trend away from densification will adversely impact coworking companies with landlords becoming increasingly unwilling to leave enough money on the table for companies to lease and then sublease space in their buildings, ostensibly engaging in the same business they are.  Landlords will be particularly reluctant to undertake landlord work and provide tenant allowance monies, rather than investing such funds in their own buildings and towards the development of their own brands.  Such development will increase landlords’ ability to provide flexible terms, as the demand for flex space accelerates, generating a predictable stream of premium rents.

The provision of branded premium priced coworking will become increasingly attractive to landlords as more enterprise companies require the regular use of space above and beyond that secured in their lease.  Such space dovetails well with an anticipated increase in the incidence of post-COVID remote work.  Moreover, such leases are attractive from an accounting perspective.  Short term leases do not have to be included on a company’s financial statements, in contrast to their longer term counterparts.

Once again, digitization will facilitate the transformation to much more intensively managed space.  Tenants will carefully monitor use of their premises, combining remote work and flexible work schedules in order to optimize their investment in office rent.  Tenants will also be monitoring productivity of its distributed workforce, comparing it with productivity levels achieved “in the office”.

Along a similar vein, retailers will pursue more pop up licenses, being reluctant to enter into long-term leases.  Retailers will also pursue early termination provisions, kickout clauses triggered when sales fall short of predetermined thresholds.  Landlords will adapt, raising rents for shorter term use at premium times, while maintaining a healthy mix of short and longer term occupancy.  Once again, digitization will help accelerate the trend.  Landlords will be able to measure the impact of different pop ups on traffic and sales, and adjust its terms and tenant mix accordingly.  Digitization will help landlords identify and reward tenants that increase traffic.

Randall Airst is CEO of Exceedant, a platform for real estate owners, occupiers, lenders and investors seeking to optimize their investment in commercial real estate. This article does not constitute either legal or financial advice. Every situation is different and solutions must be tailored to fit individual circumstances.