Publications

- March 1, 2022: Vol. 9, Number 3

Office market bouncing back, but tenants prioritizing flexibility in lease agreements

by Marc Betesh

In early 2020, the COVID-19 pandemic redefined how businesses operate. Today, they continue to grapple with the ongoing effects of shutdowns, rent crises, supply chain issues and inflation. Many have rightfully turned toward re-evaluating their commercial real estate portfolios to ensure they still support their business needs.

All of this movement has led many to believe the office property market will be negatively impacted for years to come on the assumption that many organizations will choose to either downsize or eliminate their leased space. However, a recent VisualLease survey of 400 senior accounting and finance professionals and commercial real estate executives, 200 of whom represent the perspective of tenants and 200 of whom represent the perspective of landlords, sought to understand their viewpoints heading into the new year.

Based on the findings, here are four trends we expect to unfold in 2022, ultimately signaling a rebound for commercial real estate:

RENT PRICES WILL RETURN TO PRE-PANDEMIC LEVELS

Due to many COVID-related challenges, such as mandated shutdowns and new regulations, as well as talent and material shortages, the rent crisis has greatly affected the office sector. Sixty-one percent of tenants reported that during the onset of the pandemic, they fell behind on payments, and 37 percent claim they are still behind.

However, 75 percent of landlords believe rent prices will be about the same or higher than pre-pandemic rates, and 61 percent of tenants agree. This belief is bolstered by the rising demand for office space, which hit a 15-month high in August.

The anticipated rise in rent has both parties evaluating their lease portfolios, balancing long-term goals with short-term spending. To get ahead, 65 percent of landlords are evaluating their physical space needs more than one year in advance, and 58 percent are looking to lock in leases at current rates with a minimum term of five years. This behavior indicates that while there is still a certain level of uncertainty surrounding the commercial real estate market, businesses are moving forward by reassessing their existing leases and/or exploring new agreements.

As more companies resume on-premise operations, rent prices will rise with increases in demand for space.

MANY COMPANIES WILL EXPAND THEIR FOOTPRINT

As a result of the market disruption mentioned above, many companies closed their physical locations or reduced real estate holdings to save money, comply with mandated shutdowns and capitalize on the growing remote work trend. Now, with the widespread availability of vaccines and the public’s increasing comfort level with in-person interaction, organizations are re-evaluating how much physical space they require.

For those in an office setting, shared spaces are on the rise with 37 percent of tenants and 44 percent of landlords expecting to prioritize shared desks and collaborative spaces in the year ahead. This trend is reinforced by employee behavior, as the number of in-office workers hit a new post-pandemic high in October.

In terms of the most popular locations, most landlords predict that in 2022, the greatest demand for leased office space will be in urban areas, with tier 1 cities such as Los Angeles and New York leading the way.

In support of these trends, the VisualLease study also found that 71 percent of tenants are planning to expand their real estate footprint in the new year. Consequently, we can expect to see a steady increase in the volume of leases throughout the year.

TENANTS WILL PRIORITIZE FLEXIBLE LEASE TERMS

The COVID-related rent crisis drove landlords and tenants to dispute responsibilities, causing angst for both parties. Historically, stated lease terms tend to favor the landlord, leaving tenants with fewer options. As a result, all (100 percent) of landlords reported that their tenants requested modifications to their leases in response to the pandemic, including changes to building rules and regulations, operating expenses, indemnification and insurance, subletting, rent abatement, and force majeure clauses.

With this experience, tenants have learned a valuable lesson and will now prioritize having greater flexibility in their lease agreements, with particular focus on being able to adjust the size of their space (57 percent), as well as having shorter lease durations (35 percent), flexible lease termination options (49 percent), greater ability to sublease (35 percent) and enhanced sanitation/ventilation processes (38 percent).

Going forward, landlords and tenants will partner to find more agreeable solutions to make both groups feel more comfortable entering into new agreements or modifying existing ones.

GREATER NEED FOR PROPER LEASE MANAGEMENT

Failure to get a handle on lease data can prove costly in more ways than one. Inadequate lease controls led to negative effects for 79 percent of the tenants surveyed, including an inability to respond to changing circumstances due to the pandemic (34 percent), missing an option to extend a deadline (28 percent), miscalculating lease costs (28 percent) and forgetting to update unfavorable or unwanted lease terms (28 percent).

Conversely, properly managed lease data can help tenants and landlords get more value from their leases and streamline important processes. From an operational perspective, this practice provides the data needed to better leverage their leased assets to support the strategic goals of the organization. From an accounting perspective, it streamlines the audit preparation process and helps ensure the disclosures required by the new lease accounting standards are based on complete, accurate and validated data. As such, we will continue to see an increased focus on organizations’ lease data.

Today, tenants and landlords are more acutely aware of both the risks and opportunities associated with their leases. As the markets adjust to a (hopefully) post-pandemic reality, there is a deeper need for proper lease management to facilitate the flexibility they require to remain adaptable. And this need will only persist as the industry continues to react to established and emerging challenges.

 

Marc Betesh is the founder and CEO of VisualLease.

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