Short-Term Leases Could Tank Office Valuations

Even before the pandemic, big tenants were shortening their lease terms in large cities like San Francisco and New York. COVID-19 has only accelerated that trend, with the hub-and-spoke model gaining popularity.

Lisa Knee, co-leader of EisnerAmper’s national real estate practice, thinks many tenants will ask for short-term leases, which will drive down valuations. She believes early terminations could also put pressure on valuations.

“When somebody goes in there to determine the value of the property, there’s going to be a risk each time a tenant leaves,” Knee says. “Whether it’s a short-term lease or you terminate a lease early, the appraisers or the banks are going to look at that because that’s going to create risks.”

In this environment, the landlord may face challenges finding a new tenant.

“Right now, the landlord is going to have to go back out there, re-lease up the space and possibly make more improvements to that space,” Knee says.

Currently, many companies are still under long-term leases, but Knee expects more situations arising around shorter-term leases in the near future.

“We’re not at the stage right now,” Knee says. “We’re just starting to talk about this. People were still under lease last year. Now is when I think these conversations are going to start happening.

These conversations revolve around issues like higher rent and tenant improvements. For instance, how much will landlords allow tenants to dictate lease terms with these shorter commitments?

“The landlord is going to pull back and say, ‘I’m not going to give you as many concessions because I may be out there exposed,’” Knee says.

One major place a landlord could be exposed is with tenant improvements.

“The landlord doesn’t have as much time to amortize those tenant improvements,” Knee says. “Then the landlord might not be providing such a favorable package to them [the tenant] without those rents getting higher.”

Knee thinks one answer for landlords could be creating coworking space. “The landlords themselves are going to convert their space in their own office buildings,” Knee says.

By using coworking space, landlords can get higher rent and have the flexibility to do other things with the space.

“We’ve seen the bigger names out there doing this and changing floor plans for that,” Knee says.

With coworking, office tenants can still get the flexibility they crave.

“They want to be able to have more flexibility in their leases,” Knee says. “No one really knows what’s going to happen. There’s no clarity on whether work from home is going to be a short-term or a long-term change. We know that there will be some hybrid out there where people might go in three days a week or four days a week. So that is going to impact space usage.”