Coronavirus Pandemic Has Shifted Leverage from Landlords to Tenants

The commercial real estate market was flying until it suddenly wasn’t. After more than a decade of growth we knew the day would come when the office market would weaken. What none of us saw coming was a black swan event like the coronavirus pandemic where a market that once favored landlords shifted to favoring tenants in just days. 
 
Every business in the world is developing plans for coping with the sudden economic uncertainty. With no lead time companies have been forced into experimenting with employees working from home. Unfortunately for some companies and their employees the coronavirus outbreak has already led to layoffs and furloughs.
 
After staffing cost, real estate is the largest expense for most businesses. At some point soon every company is going to look at their office lease obligation and ways for reducing that cost. 
 
The first step is to do your homework. Study your lease to understand what rights you may have to make lease changes. Audit your lease and operating expense history to evaluate if you have been overpaying. Consider bringing in a planner to right-size your space if operationally it no longer fits.
 
Then, together with your tenant representative, work with your landlord. Share with your landlord that you are seeking rent relief and are considering several options to mitigate your lease obligation. 

Sublease
 
If you need to downsize your current space, and provided your lease allows for it, listing your space on the sublease market is one way to reduce your rent cost. Companies that have suddenly found themselves with excess space are already listing their space for sublease and dropping sublease rates 20% to 30% to get their space filled quickly. 
 
Landlords want to avoid competing with multiple below market sublease listings for empty space in their buildings because a sudden flood of sublease inventory deflates the building’s overall rental rate. The possibility of another sublease in the building could also make your landlord more willing to work with you on restructuring your lease. 
 
Restructuring
 
One of the tightly kept secrets in commercial real estate is that your lease obligation is negotiable. There are two variables in your rent cost calculation. Rate and rentable square footage (RSF). Both are negotiable by either a rate reduction or contraction (giveback). 
 
Most dual agency brokers will deny it but brokers that only represent tenants know when negotiating leverage shifts from landlords to tenants, landlords suddenly become more willing to consider restructuring lease obligations. Why? Because in uncertain economic times landlords know that no one will be standing in line to pay your current rental rate for the entirety of your empty office space.
 
Even before the coronavirus pandemic hit the Bay Area sublease availability was on the rise and rent growth was slipping. When the commercial real estate market was flying it would be rare to find a landlord willing to consider restructuring your lease. That’s no longer the case.
 
Termination
 
You may not have looked at your lease agreement since the day it was executed but now is the time to see if you negotiated a termination right. Depending on the termination right you may have the ability to terminate the lease contract before the expiration of the lease term. Be aware that the landlord may maintain the right to sue for damages for early termination or charge a fee for early termination. 
 
So, given the shift in leverage from landlords to tenants, why isn’t your broker enthusiastic about assisting you in seeking rent relief?
 
More than 90% of the commercial real estate brokers are dual agents, representing both landlords and tenants.  This creates a built-in conflict of interest that few tenants understand and even fewer brokers discuss.  No one would hire a lawyer who works for the other side. Yet, the equivalent happens every day when tenants work with commercial real estate brokers and firms that also represent landlords.  
 
It is in the best interest of brokers that represent landlords to keep perceived asking rates as high as possible and vacancy rates as low as possible. But, large amounts of below market sublease space softens the market. Otherwise, landlords and listing brokers would openly publish asking and actual rents on every direct and sublease space they list.  
 
In order to gain leverage and rent relief you need to first eliminate conflict of interest by woking with a broker that only represents tenants. If your broker or anyone in their office has listings in the market, they have a conflict of interest.

Then, work together with your landlord and tenant representative to explore all options for mitigating your lease obligation – sublease, restructuring, and termination.