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o the parties should discuss the consideration for the reduction in space. This could be a lump sum, such as a “termination fee,” an extension of the lease term, credit enhancement such as a lease guaranty or other consideration determined by the landlord and tenant.
ASSIGNMENT / SUBLEASING
With more tenants looking to sublease office space, a landlord’s own tenants may become its biggest competitor for office space. When a tenant is looking to reduce its financial obligations under its lease, the tenant will usually be able to offer a subtenant a lower price per square foot than the landlord is asking of new tenants coming into the building. Allowing existing tenants to enter into subleases at a significantly lower rental rate may impact fair rental value. To guard against this, landlords would be wise to negotiate recapture rights that permit a landlord, at its option, to terminate the lease with respect to space that an existing tenant wishes to sublet. Such a provision allows landlords to maintain a higher level of control in the building.
It is important for a tenant to understand challenges involved in a sublease transaction. Besides the responsibility for managing the subtenancy, it will take time to identify a prospective subtenant and may involve construction if the space is to be divided. A sublease transaction also involves a number of transaction costs, including: (i) payment of brokerage commissions, (ii) providing “free rent” or cash as an incentive, (iii) construction costs, (iv) likelihood that the subtenant will want a “discount” from the sublandlord’s then current per square foot rental amount, (v) downtime (that is, how much time the space will be on the market), (vi) possible profit-sharing with the landlord; (vii) attorney fees to negotiate the sublease, and (viii) paying the landlord’s attorney fees (and possibly an administrative fee) to review and consent to the sublease.
LANDLORD PERSPECTIVE
What options are available to landlords facing higher vacancy rates? What does a landlord do with excess office space where the supply of available space exceeds the demand? This article touched on these questions in the earlier discussion of potential repurposing of excess space. The following are a few additional considerations.
It is important for landlords to communicate with tenants about new and enhanced operating
protocols so that tenants will feel more confident that the building is a safe working environment. While many employees are still working from home and occupancy percentages are still low, landlords may want to undertake construction projects at the building to further enhance safety precautions or to construct or enhance amenities to make the building more appealing to tenants.
This may be a good time for owners/operators to consider the right tenant mix for its building. In the past, many office landlords considered it a good idea to lease most, if not all, of a building to a single tenant. The pandemic has shown that this previously attractive strategy may have a serious downside as some large tenants are using their considerable leverage to negotiate significant concessions or failing to renew entirely. Spreading risk among multiple tenants and types of uses may be the preferred strategy in the future.
If a landlord finds itself with empty space in its building, it may want to consider building that space out into a conference room or rooms with attractive amenities and offer that space to lease to existing tenants on a reservation basis. In such event, it will be important for a landlord to have its attorney carefully review its loan documents and determine if it needs to work with its lender to implement such changes.
Some landlords, pre-pandemic, were launching their own shared office brands. Besides being a way to increase revenue for available space in the building, these shared spaces can be incubators for start- up companies that may later wish to lease larger exclusive space in the same building.
In closing, it is clear that the COVID-19 pandemic and the response of federal, state and local governments across the country have created an elevated level of uncertainty about the future of office space and how it will be used in the future. Tenants and landlords will need to carefully consider the issues raised in this article, and many others, to successfully navigate their way through. Experienced legal counsel, with an ability to think outside the box, can help determine the best path forward.
The authors, Linda Koffman, Michael Manzi, and James Porter are partners with the law firm of Smith, Gambrell & Russell, LLP. This article was first published in “Trust the Leaders 2.0” magazine and has been reprinted with permission from Smith, Gambrell & Russell, LLP. For more information, contact Linda Koffman, Partner, at (213) 358- 7218 or visit the firm’s website at www.sgrlaw.com.
APARTMENT MANAGEMENT MAGAZINE - JANUARY 2022
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