Lease Flexibility in a Post-COVID-19 World

Negotiating a Commercial Lease That Gives Your Business Flexibility

Like so many industries, the COVID-19 pandemic has significantly impacted the real estate market. As businesses are deciding what their new office will look like, whether by incorporating long-term remote work or considering downsizing their space, a lot of people are looking to landlords and building owners and expecting to see record-low rental rates — but it’s just not happening.

With office rental rates in the Twin Cities steadily rising over the past several years, many expected the pandemic and remote working to cause rental rates to come crashing down, and while rental rates have dipped, we did not see the significant decrease in rents that everyone was anticipating or what we saw back in the 2008-2009 recession.

This doesn’t mean we aren’t seeing landlords react. With the rise in remote work and a lot of businesses looking around at their empty or underused office space, landlords are finding creative ways to work with businesses looking for new space or needing to renew their lease.

Over the past several years, we have seen businesses asking for shorter lease terms from landlords than usual market terms. Tenants looking for 20,000 square feet of space or more would typically need to make a seven- to ten-year lease commitment in any building. This was due to the capital investment a landlord would make in the space for construction and build-out. Longer lease terms traditionally yielded lower lease rates and higher incentives in the form of tenant improvement allowances and free rent to help offset the cost of construction of the space. Tenants’ desire for shorter terms without outrageous lease rates was one of the main drivers behind the success of coworking spaces over the past several years.

But we’re seeing a shift to shorter, more flexible terms from traditional landlords as a response to the pandemic and the rise of coworking companies. Where once we would see a seven-year minimum lease term, tenant representation brokers are asking for three to five years, and landlords are agreeing as they recognize that many businesses value the flexibility of not being tied to a lease obligation for seven or more years. If one landlord isn’t willing to offer that flexibility, the business may start looking for another building.

Another way to increase flexibility and/or accommodate a growing company is phased occupancy. A phased occupancy plan would allow for a business to sign a lease for more square footage than they currently need to accommodate planned growth. For example, a company might be looking for new space, and based on their current headcount, they need 20,000 square feet, but their growth and hiring models show them needing 30,000 square feet in two to three years. A phased occupancy plan would allow the company to sign a lease for the 30,000 square feet now but allow them a year or two to grow into the space while only paying for the space they need right now. We’re seeing this with larger tenants and even some businesses as small as 3,000 square feet. Landlords recognize the value of a high-growth business and are willing to set space aside to accommodate their future growth.

For companies with more stable growth plans, you can still build flexibility into your lease through expansion, contraction and termination options. Having a three- to five-year lease term, or at least the ability to get out of a longer lease at these milestones, allows businesses to be more flexible in the short term rather than trying to plan for seven to ten years of space needs. A key component to managing growth is incorporating expansion and extension options within the lease. Expansion options within your lease give you the first opportunity to expand within the building. So if the suite next to your space comes available during the term of your lease and you want to expand, you can easily do so. Extension options give you the right to add additional years of term onto your lease before it expires without needing to go through the entire negotiation process again. The shorter term allows you to be more flexible with your planning but having extension options built into your lease allows you to seamlessly extend your commitment if the space is still working for you.

This shift is truly a win-win for businesses, and we’re seeing landlords react more favorably to these lease negotiation items. My advice to anyone negotiating a new lease or lease renewal in the shadow of the COVID-19 pandemic: Be more aggressive, and not just on rental rates. As always, I’d encourage companies to try to negotiate the lowest rental rate possible. However, the most important thing for today’s real estate environment is taking advantage of landlord flexibility with shorter terms, phased occupancy plans and expansion, contraction and termination options. With the uncertainty in today’s office market, companies will have the necessary leverage to do so.

 Want help negotiating your next lease or renewal? Reach out to one of our Rokos brokers!

Rokos Advisors is a Minneapolis – St. Paul based commercial real estate firm specializing in helping businesses find the perfect office or industrial space for their company.

*Article featured in the Minneapolis/St. Paul Business Journal and authored by Rokos Advisors co-founder, Pete Kostroski