COVID-19’s Effect on Commercial Real Estate Leases

COVID-19’s Effect on Commercial Real Estate Leases

Our client was days away from signing a long-term lease to relocate when COVID-19 intensified in New York, sending workers home for months. Rather than finalize the lease, our client paused the deal to gain more visibility.

120 days later, we are revisiting the lease, with adjustments. While there’s no denying that COVID-19 has created a new economic climate for office space, this article isn’t about potential changes in rent. Instead, I’m writing about COVID-19’s impact on other lease provisions, their importance critical when negotiating leases today. Below are four items to consider when negotiating leases today and in the future:

1. Timing / Free Rent during Construction:

  • Most often, a landlord delivers space to a tenant in an agreed upon raw condition and provides the tenant with a period of free rent to build the space. However, what happens to a tenant’s free rent period if there is another government mandated construction shutdown, limiting a tenant’s ability to build its space?
  • A tenant negotiating a lease now should try and move this risk to their new landlord and negotiate so that their free rent period is unaffected if there is another government mandated construction shutdown. Specifically, it’s free rent period should continue day for day until such construction shutdown is lifted.
  • While a complete shutdown would be most onerous for a tenant when building its space, during negotiations with its prospective new landlord a tenant can try to expand this concept of unaffected free rent to include other COVID-19 related delays, such as delays in obtaining materials, labor slowdowns due to social distancing or someone on the construction crew testing positive and the team needing to quarantine, etc.
  • A tenant today may also want to have its new landlord indemnify it of an existing holdover if it’s move into the new office is delayed because of a construction shutdown. Of course, the ability to negotiate for this (and for any of the items mentioned in this article) is dependent on the unique situation of the tenant, building, owner, size, etc.

2. Operating Expenses:

  • There will likely be an increase in building operating expenses as a result of new laws/recommendations on how buildings should be run. Examples of where operating expenses may increase include enhanced cleaning to common areas, thermal scanning and owners supplying PPE to staff and visitors. 
  • If operating expenses increase due to additional building services added in response to COVID-19, a Tenant should ask that the operating expense base year be adjusted upwards to include those expenses. Landlords may ask for a base year reduction if the additional services are unnecessary in the future, which is fine. 
  • Tenants that have leases in place now need to pay attention to what may happen with their building’s operating expenses in the near-term since most leases allow for these costs to be allocated to tenants.

3. Cleaning:

  • Cleaning services and costs will increase, but who will be responsible for providing the services and paying for them?
  • Since it’s too early to know how cleaning services will change – and it’s possible they will change pre and post vaccine – tenants negotiating leases now can argue that a Landlord enhances cleaning specifications consistent with other like-kind buildings/owners (i.e. consistent with other Class A Midtown buildings.)

4. Base Building Pandemic Upgrades:

  • Before signing a new lease, tenants should ask what their landlord is contemplating for pandemic related base building and common area upgrades. For example, is the landlord installing touchless turnstiles, elevators and bathroom fixtures, or upgrading the base building HVAC filters?

The general theme emerging from COVID-19 is that there will be more sharing of risk between tenants and landlords in future leases, whereas most of the financial risk during this pandemic has been felt by tenants as they are obligated to pay rent but have not been able to occupy.

While COVID-19 has created new lease issues to consider, working with smart brokers and lawyers will get your company through this crisis. If you have any questions on your specific situation, please get in touch.

Thanks to my Dad and CBRE Vice Chairman, Howard Fiddle, for reading drafts and offering feedback on this paper.