The pandemic will have a significant long-term impact on the
commercial leasing market as companies re-evaluate the ways they do
business and their real estate needs. For example, many companies
are considering doing away with, or reducing the size of, retail
locations in favour of online operations, having employees work
from home, or maintaining a physical location in urban centres but
with inventory and storage facilities located in lower-cost
suburbs.
This article sets out some of the key considerations in weighing
a tenant’s lease options going forward. Specifically, this
article discusses lease renewals and extensions as well as
subleasing space.
One factor to note is that the demand for a type of space
affects the leverage between the landlord and tenant in lease
negotiations. Generally speaking, industrial space has been the
least-affected by the pandemic, as many industrial operations were
deemed essential services by the government. The most immediate
effects of the pandemic have been on retail space, particularly
enclosed malls given mandatory closure orders, the increase in
online shopping and the rash of retailer bankruptcies.
We anticipate that new office space will continue to become
available, given the insolvency of some companies as well as others
making strategic decisions to reduce the size of their
space.1
Lease Renewals and Extensions
With a lease approaching the end of its term, some tenants may
decide that remaining in their current space makes the most sense
for their business and will exercise their option to renew or
extend their lease. Key factors that tenants should take into
consideration include (i) customer convenience, (ii) reputation in
the area, (iii) access to transportation and supply chains, (iv)
the market for the particular type of space and (v) availability of
alternative spaces.
Focusing on factors (iv) and (v) above, tenants may be able to
leverage the higher vacancy rates for commercial spaces,
particularly as it relates to retail and office spaces, to
renegotiate rents at lower rates than what is currently being paid
under their lease. While most renewal and extension provisions
generally provide that the base rent for a renewal or extension
term cannot be lower than the base rent of the immediately
preceding term, the uncertainty resulting from the pandemic has
created a unique environment for negotiation.
Tenants should remain cognizant of the deadlines provided in
their lease by which they must provide landlords with notice of
their intent to exercise their options to renew or extend. Tenants
should not wait until the last minute to engage landlords in
renegotiations and to begin conducting their due diligence on
alternative options. Instead, tenants should proactively
communicate with their current landlords, and explore alternative
options far in advance of any notice deadlines in order to put
themselves in the best position to make the most prudent business
decision in the context of leasing space.
While there may be room for renegotiating rent for retail and
office spaces, the same likely cannot be said for industrial
spaces. So far, industrial lease rates throughout Metro Vancouver
remain largely unchanged from those negotiated in the first quarter
of 2020 and there has been virtually no discounting or rate
reductions at renewal for deals completed after the end of the
first quarter of 2020.2
Subleasing Space
For tenants with multiple years left in their lease term who are
occupying a footprint larger than they require, subletting excess
space should be considered. Alternatively, tenants should consider
negotiating an early termination of their lease and subletting
space from another tenant. Patterns concerning the subletting of
space already appear to be emerging as the amount of office space
being subleased in downtown Vancouver is at twice the historical
average.
From a subtenant’s perspective there are many benefits with
subleasing space, including shorter, and likely better, terms. From
a sublandlord’s perspective, there are potential networking
opportunities if the subtenant operates a business that is
complimentary with that of the tenant’s as well as retaining an
option to reclaim the subleased space once the long term affects of
the pandemic on businesses patterns become known (i.e. keeping open
the possibility of moving back into the subleased space once the
sublease term expires and information is available regarding long
term economic outlooks).
Along with the potential benefits, tenants will also need to
turn their attention to potential costs associated with dividing
the space, obtaining the landlord’s consent (the terms of the
lease should be reviewed), preparing sublease documentation and the
business reality of being in the space for a shorter term.
Depending on the amount of time remaining on the existing lease
term, the costs associated with subletting the space may be modest
compared to the costs that may be incurred by a tenant for
retaining space that is not being used.
Conclusion
There is a significant amount of uncertainty surrounding what
the post-COVID-19 world will look like. While there are many
companies which have already determined that they will not require
the physical space they currently occupy, and are thus thinking of
exit strategies with respect to their leases, there are many other
tenants who will be looking for short-term flexible solutions to
assist with navigating these uncertain times.
Regardless of what side of the equation businesses fall on, it
is always possible to find creative and practical solutions which
benefit both tenants and landlords. Speak with one of our
Firm’s commercial leasing experts to understand what options
are available to you.
The authors of this article gratefully acknowledge
the contributions of summer student Mac Hayden.
Footnotes
1 For example, Vancouver’s downtown office vacancy
rate rose to 3.3% this quarter, up from 2.2% a quarter earlier and
Toronto’s downtown office vacancy rose to 2.7% in the second
quarter, up from 2.0% in the first quarter. Additionally, rents for
office spaces also fell in each city, with Vancouver seeing a drop
of $1.62 for Class A office space and Toronto seeing a drop of
$1.53 for such space
(www.cbre.ca/en/about/media-center/cbres-second-quarter-statistics-show-covid-19s-impact-on-canadian-commercial-real-estate)
2 Ibid.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
