Due to the effects of COVID-19, the commercial office market should generally shift in favor of tenants in the next few years. Law firm tenants should find an environment that is characterized by friendly concessions, options across asset classes and price ranges, and limited space competition.
Here are some market factors:
What does all this mean for your law firm? When negotiating a new lease or renegotiating an existing one, there are seven provisions to keep in mind:
- Contraction option. A contraction option is a right to reduce the size of a tenant’s rented premises. If office space needs change, the company may want to reduce the square footage. If you’re trying to cut down on your law firm’s space, you should be ready to negotiate responsibility for the cost of physically redeveloping the space.
- Shorter terms. Commercial office landlords generally want longer term leases (typically seven to ten years) to maximize the value of a building for financing purposes. Conversely, tenants prefer the inherent flexibility of shorter leases. Given the expected oversupply for the next few years, be prepared to negotiate a shorter rental period, being aware that a shorter lease may affect the landlord’s willingness to fund land improvements and other financial incentives such as free or reduced rent.
- Early termination option. Be prepared to have a trial period when trying to quantify office space needs. If there is a significant oversupply of office space, a law firm could become a kind of “office nomad” and move into less expensive spaces (through direct or subletting) as soon as these spaces become available. In order to take advantage of the oversupply of office space, you should negotiate an early termination or an exit clause. Such a clause can come at a price, as a landlord can insist on a cancellation fee. This fee usually reflects the landlord’s unamortized upfront costs, such as brokerage commissions and fitout costs, along with some amount of foregone rental income.
- Option to expand. An extension option (sometimes referred to as an extension option) provides a tenant with the ability, but not the obligation, to extend or renew a lease beyond the basic term of the lease. The right to extend or renew a lease in conjunction with a shorter basic term essentially gives your company the security of a long-term lease with no corresponding inflexibility. Conversely, if changes make the company’s lease impractical, then you have the right to leave the lease after the basic term has expired.
- Right to use rooms outside of the premises. Since the space requirements will certainly continue to develop, buildings with flexible “office-hotel space”, shared desks, meeting and collaboration rooms and benches outside the rented premises of the tenant may become more common. With this alternative, look for office properties “as required” that your company can use free of charge or for a fee. Having such a space “in reserve” and being available to the company offers another level of flexibility.
- Restrictions on transit costs. Typically, operating expense provisions allow landlords to bill a tenant for a tenant’s share of a very wide range of costs and expenses. Due to COVID-19, structural and operational changes are inevitable. Landlords can be, for example:
- Reconfiguration of public areas such as lobbies and elevators to maintain appropriate social distance,
- Integration of technologies to protect people from exposure, including temperature measurement and UV disinfection devices,
- Modernization of heating, ventilation and cooling systems to improve air filtration and,
- Increase in building service staff such as day porters to disinfect areas during a working day.
These measures are costly. Does your company’s lease contain a provision for operating costs and, if so, will the landlord’s COVID-related operating costs be passed on to the company? You should carefully review the utility expense provision in your rental agreement to determine to what extent you are responsible for any increased operating costs that may be related to COVID.
- Reductions in force majeure. Finally, although lease negotiations correspond to successfully regaining an onside kick, you should try to include wording in your lease that defines government-ordered pandemic shutdowns as force majeure events, which in turn reduces the company’s obligation to do so during that time Pay rent. This provision, if successfully negotiated, can prove critical in the unfortunate event of a new outbreak.
As someone much smarter than the authors – Einstein – once said: “In the midst of difficulties lies an opportunity”. Take advantage of market conditions and take the chance to rethink your rental needs, pursue tenant-friendly options, and increase your flexibility for a potentially uncertain future.
Timothy M. Hazel is a partner at Pietragallo Gordon Alfano Bosick & Raspanti and a member of the firm’s business and society practice group. During his nearly two decades career, Hazel has represented law firms, public and private corporations, landlords and tenants in a variety of complex rental transactions.
Gaetan J. Alfano is a partner and board member of the firm. In his 40 year career, he has handled numerous cases of commercial disputes between law firms and attorneys.