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The Double-Edged Sword of Lease Renewals

Posted by Anne on May 20, 2024
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By Dean Blackey, Managing Director, R. W. Holmes

In the ever-changing landscape of commercial real estate, the decision to renew or not renew office leases has become a topic of great interest and strategic importance. Historically, lease renewals were pretty straightforward: tenants had options built into their contracts requiring them to notify landlords of their departure 6 to 12 months in advance. This mechanism encouraged tenants to explore the market and consider alternative leasing options before deciding whether to renew their existing lease. It was an integral part of our system, essential for maintaining market dynamics and stimulating competition.

However, this cyclical approach to lease renewals has undergone significant changes, particularly highlighted by the market’s response to the COVID-19 pandemic.

In the past, when the market was strong, landlords had the leverage to demand more from their tenants. Typically, they expected a commitment of five to seven years. Landlords often assert that renewal rates would not be lower than what the tenant was currently paying and would likely increase. They felt confident enough to make those demands, knowing that the market was strong enough that if they lost a tenant, they could backfill the void quickly.

The pandemic brought these dynamics to a screeching halt. With uncertainty looming and many offices becoming totally unoccupied overnight, landlords faced a new reality in which the potential loss of a tenant became a critical hit to their bottom line, one they envisioned snowballing into systemic vacancy from their once stable asset.

Landlords experienced genuine angst during this period, and our advice to them was straightforward: use any means necessary to manage the crisis and prioritize the retention of your tenants no matter the cost. The alternative, of course, would be an indefinite vacancy as the prospect of finding a replacement tenant at the time was virtually zero.

In response, landlords became much more accommodating in their renewal demands. They moved away from insisting on long multi-year commitments, instead offering more flexible terms such as annual or even month-to-month arrangements. Rent reduction became common for the first time in over a decade as landlords asked tenants to communicate their specific challenges so that solutions could be tailored to fit their needs. If a tenant was in 10,000 sf but was only utilizing half the space, it was: “Stay in the 10k, pay on the 5k, and we can reassess in a year”. On the flip side, company owners were more than willing to put any serious decisions about their office space off as long as possible (they themselves not knowing if and when their employees would rejoin them in the office).

Regardless of the methods landlords used to “triage” the situation, they did so with the belief that, at some point, things would simply go back to the way they were….

However, now that we are four years removed from those dark days, it is clear that the great return to “normal” hasn’t come to fruition as most had hoped.

The persistence of the work-from-home trend has complicated matters for property owners. As landlords observe significantly less usage of parking facilities and other amenities, they realize the extent of the reduced physical presence in office buildings. This stark reality has prompted landlords to walk through their eerily quiet buildings, reinforcing their commitment to maintaining flexible, tenant-first strategies. Consequently, they continue to prioritize the retention of tenants, adapting their leasing approaches and offering whatever concessions are necessary to keep tenants satisfied and in place.

The confluence of all of this has had both a positive and negative impact on the suburban office market. On the one hand, building owners have been able to retain existing tenants to a far greater degree than anyone expected, which has helped stem the tide of negative absorption (tenants leaving, thus creating vacancies.) While on the flip side, this increased retention has created a lack of motivation by tenants to explore alternative leasing options, which has greatly impacted positive absorption (tenants moving and signing new leases). For this reason, if you ask most office brokers, they will tell you leasing activity has remained woefully stagnant for years now.

For tenants, this shift has opened up a plethora of options. The market now varies significantly even between comparable buildings on the same street (with some landlords significantly more aggressive in their concessions than others). Current conditions provide tenants with the opportunity to upgrade their spaces, seeking out amenities that can entice employees back to the office full-time. The modern workplace requires more than just space; it needs an attractive, functional environment that employees are eager to reengage in.

Meanwhile, tenants who are content with their current arrangements also stand to benefit. By exploring the market, they can gain leverage to negotiate more favorable terms with their existing landlords, possibly securing perks such as extended periods of free rent or customized buildouts.

I think tenants and business owners are settling into the fact that this is the new norm.

To landlords, I continue to advocate maintaining a flexible mindset, particularly with existing tenants. Engage with them well in advance—up to a year before lease renewals—to understand their future plans and concerns. Continue to offer short-term agreements if necessary, keeping rents stable and accommodating tenants as they navigate the ongoing challenges posed by a hybrid landscape. By being proactive and aggressive in these strategies, you can ensure tenant retention and stability in these uncertain times.

For tenants, it’s important to recognize that the current market is in your favor. Don’t hesitate to explore different leasing options. Even if you’re not planning to move, gathering information about what’s available can provide valuable leverage when renegotiating terms with your current landlord.

As the market evolves, navigating lease renewals demands the expert insight and strategic foresight that only a seasoned real estate advisor can provide. Partnering with a professional advisor ensures that you make well-informed decisions and maximize your negotiation leverage. Contact us today if you are considering renewing your lease or exploring new options. Let us help you optimize your leasing strategy and secure the best possible outcomes for your business.

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