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By: Kim Seib, Sara Kolb, and Rebecca Calzontzi, Practical Guidance Real Estate Team
This article uses survey results and graphics collected from the Practical Guidance Survey of Commercial Lease Terms to explore commercial leasing trends and the impact of COVID-19 on the commercial leasing market. Click here to take the survey and gain access to the latest market standards for more than 40 leasing deal points.
COVID-19 upended the commercial leasing market. Some impacts were immediate: tenants stopped paying rent, demand for office and retail space plummeted, businesses and properties that relied on physical density became untenable, seemingly overnight. While the initial scramble to deal with COVID-triggered disruption has settled down, longer-term impacts will turn on behavioral changes and are still working themselves out. How many Americans will return to the office? Will the open floor plans embraced in recent years fall out of favor? Will employers shift workers out of cities to save money?
“I think it’s inevitable that, in the short-term, tenants are going to continue to try to downsize. In the office market, tenants have realized that they need less space to function – their employees have successfully navigated working from home,” says Michelle McAtee, co-chair of Jenner & Block’s Real Estate Practice. McAtee thinks this will change—but only to a point. “In the long-run, I do think there will be a bit of a recovery, as we all realize that certain things happen better in person. But I don’t predict a return to where we were pre-pandemic,” says McAtee.
Even with so much in flux, leasing carries on and attorneys continue to negotiate leases with the same concerns as always—How much can I get for my client? What’s market right now?—except now these concerns are being reshaped by COVID-19. Negotiating standard leasing clauses like interruption of services, termination options, and force majeure has taken on a new sense of urgency as attorneys adapt to changing times. “Force majeure provisions are the hot topic right now,” reports McAtee, “and if they did not already include references to pandemic and civil unrest, tenants are certainly pushing for them now.”
Most leases are not publicly filed, and it has never been easy to determine what’s market. Even in stable times, real estate attorneys often find themselves turning to old-fashioned listservs and message boards for information and insight. It is probably safe to say that most real estate attorneys are not risk takers by nature, and this desire for information is typically countered by concerns over client confidentiality or losing a competitive edge. But as the need for up-to-date information becomes crucial in the COVID and post-COVID world, real estate practitioners are likely to seek new avenues and tools to access information on the latest leasing trends.
To meet this need, Practical Guidance recently launched its Survey of Commercial Lease Terms. This ongoing survey provides up-to-date intelligence about the commercial leasing market and gives real estate attorneys a clear view of market standards and trends to aid in lease negotiations. Drawn from the survey, this article highlights COVID-specific leasing data and attorney insights on the pandemic’s immediate impact on lease negotiations. It also summarizes key retail and office lease terms for use in negotiating and gauging the market going forward.
The data set referenced in this article includes 299 recently negotiated commercial leases obtained from private sources. These leases are spread across the country, with 26% located in the northeast, 26% in the west, 24% in the southeast, 11% in the southwest, and 11% in the midwest. (Approximately 1% of respondents did not identify a location.)
Office leases (60%) are in the majority, followed by retail (30%) and industrial (10%) leases. The leases include triple net (42%), gross or full-service (30%), and modified gross (28%).
Click here to take the survey and access the latest survey results
Survey results indicate that in response to COVID-19, many parties restructured force majeure provisions, delayed lease negotiations, and made significant changes to general lease terms such as rent abatement and termination rights.
The majority of survey respondents observed effects on lease negotiations that were pending at the start of the pandemic, including negotiations that were put on hold or halted entirely. When asked about leases that were under negotiation when the COVID-19 pandemic began, over 70% of respondents stated that they observed one or more of the following:
Not surprisingly, many parties have needed to modify their existing leases during the pandemic. McAtee of Jenner & Block reports that lease modifications and amendments have “been the focus of my practice during the pandemic.” When asked about the tenor of these negotiations, McAtee was largely positive: “Generally speaking, it has been less contentious than it has been collaborative. Both tenants and landlords have worked through the difficulty of the situation.” However, the news is not all rosy for landlords, and McAtee added, “On the other hand, tenants have tended to ask for more than they have in the past. There has been a general feeling of landlords being a bit stuck—they would rather have a paying tenant, even if for less space, than no tenant and empty space without much of a market for reletting.”
Looking to the survey, 55% of respondents have recently restructured a lease or negotiated a lease amendment due to COVID-19. The modifications identified included the following:
A force majeure clause is a contract provision that excuses a party’s performance of its contractual obligations when certain circumstances arise beyond its control. The clause typically lists a series of events that constitute a force majeure event and imposes specific obligations on the party seeking to invoke the clause to excuse its performance. Events such as acts of God, weather conditions, war, government orders, labor strikes, and the inability to obtain materials are among the excuses that a force majeure provision typically contains.
Since the onset of the COVID-19 pandemic, force majeure provisions have become a central focus of many lease negotiations. Tenants facing financial hardship are looking to force majeure clauses to excuse (or delay) their lease obligations while staying in possession of their premises. Landlords, on the other hand, are pushing for restrictive force majeure clauses to protect their rental income. And parties on both sides are considering whether to modify existing leases or lease forms going forward to account for the pandemic’s effects.
Approximately half of all survey respondents stated that the force majeure clause in their lease specifically covered one or more of the following pandemic-related events:
Of the respondents whose force majeure clauses did not include any of the events listed above, 52% plan to restructure their provisions to include one or more of them, as follows:
Survey responses also show the direct effect of COVID-19 on force majeure provisions over time. Only 45% of leases from 2018 and 20191 included one or more of the events listed above in their force majeure clauses, and only 4% listed pandemics specifically as a force majeure event. Of the leases from March 2020, 57% included one or more of these events as a force majeure, and 21% specifically listed pandemics. And in the second, third, and fourth quarters of 2020, over 60% of leases included one or more of these events as a force majeure, and over 30% specifically listed pandemics.
Business Interruption Insurance
Property insurance policies often cover only the cost of repairing and replacing damaged property, not consequential economic losses. Business interruption insurance can help fill in the gap, covering certain types of economic losses that a business suffers when it is unable to operate for a period of time.
Some landlords require their tenants to carry business interruption insurance to ensure that, even if a tenant’s business is disrupted, it will still be able to make rent payments. Survey responses show that the COVID-19 pandemic may be leading more landlords to include a requirement for business interruption insurance in their leases: Only 32% of leases from 2018 and 2019 required tenants to carry business interruption insurance, compared to 50% of leases from 2020.
Landlords sometimes agree to grant rent abatements if they are unable to provide essential services to their tenants for a certain period of time. McAtee reports that in her practice “the interruption of services provision is getting more attention than ever, with tenants pushing to provide that rent abates if they cannot use their premises due to any interruption, including due to state mandates. The key here is that tenants want the lease to provide that that determination is made by them and not the landlord.”
While only 46% of leases surveyed include a rent abatement provision, they reveal a trend shaped by the pandemic. Of the leases from 2018 and 2019, approximately 40% gave the tenant this abatement. The percentage of leases with an abatement provision increased dramatically to 86% in March 2020, and then dropped back down to 40% in the second, third, and fourth quarters of 2020. It remains to be seen if this trend will shift upward once again as the pandemic continues into 2021. As more survey results are generated in the coming months, attorneys will be able to monitor and assess what is market for rent abatement provisions in a pandemic and post-pandemic world. Click here to take the survey and access the latest survey results.
Tenant Termination Option
Only 34% of leases from 2018 and 2019 gave the tenant the option to terminate the lease prior to the end of the term. There was a slight increase in leases with a tenant termination option in March 2020 (36%), but only 25% of leases after March 2020 contained this provision. While the percentages here did not range as widely over time as with rent abatements, responses indicate that landlords may be granting tenant termination options less frequently now than they were before the onset of COVID-19.
Looking ahead, longer-term impacts of the pandemic, including lingering economic uncertainty, have the potential to influence both landlords’ and tenants’ approaches to many standard lease provisions. Some of these provisions are discussed below, through an examination of recent market trends.
Base rent for retail space is usually calculated on a per square foot basis and paid in monthly installments. Typically, base rent is increased at the beginning of each lease year or 12-month period at an agreed upon rate.
In addition to base rent, retail tenants may also pay percentage rent, meaning a share of sales, as well as some portion of the operating expenses, insurance, and real estate taxes associated with the operation of the property. The survey reveals that only 28% of recently negotiated retail leases require the tenant to pay percentage rent. However, some analysts suggest that because percentage rent provides the flexibility needed to deal with business interruptions, it is becoming more appealing to both landlords and tenants and that its appeal may outlast the pandemic.
Notice and Cure Rights for Default
All commercial leases contain provisions detailing the acts or omissions of the tenant that will result in a lease default and the landlord’s remedies following a default. Typically, the tenant tries to negotiate for written notice, grace periods, and cure periods for specific defaults while, for their part, landlords are reluctant to waive or limit any remedies they may have following a tenant default. As the pandemic and its after-effects continue, tenant defaults are likely to rise, perhaps leading to an increased focus on notice and cure rights in lease negotiations.
In over half of the retail leases surveyed, the tenant successfully negotiated for notice and cure rights for not only nonmonetary defaults (71%) but also monetary defaults (59%). 23% of retail leases did not include any notice and cure rights. Five retail leases granted cure rights for monetary defaults only while 16 retail leases granted cure rights for nonmonetary defaults only.
The amount of notice/time to cure given to retail tenants following default varied widely. For monetary defaults, most tenants were entitled to between three and 15 days, although more than 20% of those with notice and cure rights received 30 days or more. For nonmonetary defaults, the notice/cure periods also varied, but over 50% of tenants with notice and cure rights received 30 days or more.
As with retail leases, in a majority of the office leases surveyed (78%), the tenant was able to negotiate for notice and cure rights for nonmonetary defaults. Over half of office leases (67%) also provided for notice and cure rights for monetary defaults. 19% of office leases did not include any notice and cure rights.
Of the office tenants that were granted notice and cure rights for monetary defaults, 70% were entitled to no more than 10 days’ notice and cure. 13% of these tenants received 30 days’ notice and cure, and only 3% received 60 days’ notice and cure.
While the length of notice and cure periods for nonmonetary defaults varied among office leases, the majority of office leases with this notice/cure period (51%) gave tenants 30 days’ notice and cure.
Landlords typically require lease guaranties when they have concerns about the tenant’s financial strength or experience. But financial hardship caused by COVID-19 may lead both landlords and tenants to look to guaranties for protection and leverage. Landlords might be more likely to require substantial guarantors if they are concerned about their tenants’ ability to pay rent going forward. At the same time, some tenants might offer up guarantors in return for concessions, such as a delay in initial rent obligations or a reduction in security.
67% of the retail leases surveyed were guaranteed. 60% of retail leases with guaranties had full guaranties while the remainder had guaranties that were limited in some way.
Two regional differences stood out:
Office leases in the survey were less likely than retail leases to be guaranteed, and a slight majority (54%) were not guaranteed. 62% of office leases with guaranties had full and unconditional guaranties and 38% had guaranties that were limited in some way. 27% of the limited guaranties were identified by respondents as good guy guaranties; as with retail leases, all were in the New York City market.
As with a guaranty, whether a landlord requires a security deposit is often tied to the tenant’s financial strength. Once again, continuing instability resulting from COVID-19 is likely to increase landlords’ focus on security deposit requirements.
69% of retail leases required a security deposit. In 18% of these leases, the tenant was entitled to interest earned on the deposit.
The numbers are similar for office leases, where 71% required security deposits and 29% did not. In 15% of office leases with a security deposit, the tenant was entitled to receive interest earned on the deposit.
Frequently, improvements or alterations are required to make the leased premises usable by the tenant. These are referred to as tenant improvements. Tenant improvements can be as simple as installing new carpeting, though sometimes the alterations are significant enough to cost several millions of dollars. If, as some have suggested, a long-term effect of the COVID-19 pandemic will be a distaste for open floor plans, both Landlord performs the work and pays for the entire buildout 13% Landlord performs the work and pays up to a certain amount 21% Tenant performs the work and receives a TI allowance 42% Tenant performs the work and pays, no TI allowance 4% Other 20% BUILDOUT PERFORMANCE AND PAYMENT RETAIL office and retail space may require more significant alteration than in the past to be acceptable to tenants. Responsibility for both performing and paying for this work is likely to be a key negotiating point post-COVID-19.
Tenant improvements are common in both retail and office leases but can be more complicated and heavily negotiated in retail leases. For the average retailer (whose space can be quite individualized and distinct), the necessary work typically consists of more than mere cosmetic changes. In many cases, the tenant will work with the landlord and, if applicable, an architect or contractor to agree upon a scope of work and at least preliminary pricing before the lease is actually signed. The business terms agreed upon by the parties before a lease is drafted typically include the amount of any agreed-upon tenant improvement allowance and which party will be responsible for completing the work that needs to be completed before the tenant takes occupancy or opens for business. A retail tenant will often prefer to do the work itself; it may have a concept or brand that it desires to put in place, it will likely be more familiar with the buildout, and it might even have preferred contractors or subcontractors with whom it wishes to work. At a minimum, the landlord will want the ability to approve the contractors and the plans and specifications for the work.
To induce a tenant to lease space in the landlord’s building, the landlord may agree to pay a tenant improvement allowance. Tenant improvement allowances are lump sums of money that the landlord makes available to the tenant to customize the leased premises to the tenant’s specifications. Sometimes the tenant improvement allowance will be paid to the tenant in the form of a rent credit, but more frequently it comes in the form of a reimbursement by the landlord for the tenant’s construction costs.
Tenants should be sure to negotiate an appropriate remedy should the landlord fail to fund any allowance to a tenant when it is due and owing, such as an offset right against rent. This provision is typically included in a work letter agreement, if there is a separate one, but can also be included in the lease itself.
59% of retail leases included in the survey required some sort of initial buildout of the leased premises. The survey also reveals how the cost of and responsibility for performing the initial buildout was allocated. Understanding these trends and prevailing terms can provide valuable insight when negotiating the tenant improvement clause in a retail lease.
The survey shows the following allocation of responsibility for the performance and payment of work under retail leases with a buildout:
The survey reveals that 54% of recently negotiated office leases required an initial buildout, with the following allocation of responsibility for the performance and payment of work under those leases:
Common leasing options—those granting extension and termination rights as well as rights of first refusal (ROFR) and rights of first offer (ROFO)—provide tenants with flexibility should their needs change, which is desirable in an uncertain world. Whether more tenants will successfully negotiate for these options post-COVID-19 in unknown. In fact, as explained in the COVID-19 Impact section above, although the inclusion of termination options in commercial leases increased in the initial stages of the pandemic, this trend may have already run its course. As for extension options, ROFRs, and ROFOs (see data below), one unanswered question is whether the options will actually become less common if tenants choose to forgo them in exchange for securing things like rent flexibility and concessions. As more leases are added to the survey in the coming months, we may be able to answer this question. Click here to contribute your leasing data to the survey.
Extension options were common among retail leases with 70% of retail leases including this type of option. The majority of retail leases with extension options (60%) required the tenant to provide the landlord with 1-6 months’ notice to exercise the option.
The full breakdown is as follows:
Extension options were the most common option found in the office leases surveyed. Over two-thirds of office leases granted the tenant an extension option while fewer than one-third did not. Of those leases with extension options, 50% required the tenant to give the landlord 1-6 months’ prior notice to exercise the option. The full breakdown of notice requirements is as follows:
Of the office leases with extension options, 30% used fair market value to determine rent during the extension term and 8% used CPI. The remaining office leases provided for either fixed rental rates set forth in the lease or other rates to be agreed upon by the parties.
68% of retail leases had neither an ROFR nor an ROFO. 32% had one or the other; ROFOs were fairly uncommon and were included in only 10% of retail leases, while 22% of retail leases had a ROFR.
20% of office leases gave the tenant an ROFO. ROFOs were most commonly found in New York City office leases. ROFRs were fairly uncommon in office leases, with only 8% including them. 71% of office leases contained neither a ROFO nor a ROFR.
To take the survey and gain access to the latest market standards for over 40 leasing deal points, click here.
Kim Seib is a Content Manager with the Practical Guidance Real Estate team. Before joining LexisNexis, Kim practiced with a number of New York City-based law firms, focusing primarily on commercial real estate transactions.
Sara Kolb is a Content Manager for Practical Guidance in its Real Estate practice area. Before joining LexisNexis, Sara represented purchasers, borrowers, and sellers in acquisitions, financings, and dispositions of large-scale commercial projects throughout the United States.
Rebecca Calzontzi is a Content Manager for the Practical Guidance Real Estate team. Rebecca practiced law for nine years, first as a finance associate at Debevoise & Plimpton LLP and then as a real estate associate at Lazer, Aptheker, Rosella & Yedid, P.C. Rebecca represented clients in a wide range of real estate transactions, including commercial leasing matters and the purchase, sale, and financing of commercial and multifamily properties.
For guidance on drafting and negotiating retail leases, see
RETAIL LEASE AGREEMENTS and RETAIL LEASING RESOURCE KIT
For guidance on drafting and negotiating office leases, see
OFFICE LEASE AGREEMENTS and OFFICE LEASING RESOURCE KIT
For guidance on guaranties in a retail leasing transaction, see
GUARANTY OF A RETAIL LEASE AGREEMENT
For guaranty forms to use in a retail leasing transaction, see
GUARANTY (PERSONAL GUARANTY, RETAIL LEASE), GUARANTY (GUARANTY BY CORPORATION, RETAIL LEASE), and LIMITED GUARANTY OF LEASE (RETAIL LEASE)
For guidance on guaranties in an office leasing transaction, see
GUARANTY OF AN OFFICE LEASE AGREEMENT
For guaranty forms to use in an office leasing transaction, see
GUARANTY (GUARANTY BY CORPORATION, OFFICE LEASE) and GUARANTY (PERSONAL GUARANTY, OFFICE LEASE)
For an overview of the statutes governing the amounts, collection, and return of security deposits in each of the 50 states and the District of Columbia, see
SECURITY DEPOSIT (RESIDENTIAL AND COMMERCIAL LEASES) STATE LAW SURVEY
For a form of work letter, see
TENANT’S WORK LETTER (RETAIL LEASE)
For a related discussion of work letter agreements, see
WORK LETTER AGREEMENTS
For a sample form that is used when the landlord performs the work and pays the costs up to an agreed-upon allowance with the tenant assuming the responsibility for any excess costs above and beyond the allowance, see
WORK LETTER AGREEMENT (LANDLORD PERFORMS WORK, ALLOWANCE)
For guidance on expansion options in commercial leases, see
EXPANSION RIGHTS PROVISIONS IN COMMERCIAL LEASES
For sample clauses granting the tenant expansion rights, see
EXPANSION OPTIONS CLAUSES (PRO-LANDLORD)
1. Leases identified in this article as being negotiated in a particular year refer only to those stated as being from that year by the respondent.