By Soozi Jones Walker , CCIM , SIOR
SURVIVING VOLATILITY
The coronavirus pandemic turned the world upside down , so CRE professionals will need creative options when it comes to renegotiating leases .
Disruptions happen all the time . The next one is sure to come — what remains unknown is what form it will take and when . The COVID-19 pandemic , for instance , is a black swan event that could take a century of hindsight to put it into proper context by the type and scope of its impact . While this latest disruption is unlike previous systemic volatility , like the Great Recession , commercial real estate professionals need to adapt to the changes resulting from this most recent disruption .
One such change requires that industry pros hone their abilities to prepare for the widespread lease renegotiations in the coming months and years . Leases tend to be long-term contracts in CRE , extending three , five , 10 , or 20 years into the future . In that time , businesses will change , and the economy will have its ups and downs . When a tenant and landlord sign a lease , there is typically an anticipation that the market and use of the space will continue uninterrupted throughout the term of the agreement . While early termination clauses are not uncommon in the office sector , the cancellation fees can be hefty .
In the wake of the pandemic , tenants and landlords / owners are renegotiating and modifying leases every day . Pinterest , as an example , recently cancelled a lease for 490,000 sf of office space in San Francisco that included total rent payments of $ 440 million . The cost to walk away from that deal was an astonishing $ 89.5 million . Why would a lessee pay that much to buy its way out of a deal ? Risk .
Sublease Rent Is Lower Than Contract Rent
EOY Sublease Rent Contract Rent Difference 1 $ 45,000 $ 50,000 ($ 5,000 ) 2 $ 45,000 $ 50,000 ($ 5,000 ) 3 $ 45,000 $ 50,000 ($ 5,000 ) 4 $ 45,000 $ 50,000 ($ 5,000 ) 5 $ 45,000 $ 50,000 ($ 5,000 ) 6 $ 45,000 $ 50,000 ($ 5,000 ) 7 $ 45,000 $ 50,000 ($ 5,000 ) 8 $ 45,000 $ 50,000 ($ 5,000 )
Present Value at 10 % ($ 26,675 )
Risk also explains why significant amounts of subleased office space has been hitting the market . Some tenants , seeing the volatility of 2020 and the near future , hope to minimize costs and recoup some revenue from their decreased need for real estate .
The commercial real estate market remains volatile , even if we all hope the worst of COVID-19 is behind us . Considering such uncertainty , plenty of tenants and landlord / owners will be faced with the prospect of subleases and buyouts in the coming months and years . Here ’ s a quick rundown of many of the considerations that go into lease modifications .
SEEKING A SUBLEASE At its most basic , a sublease is an exit strategy for the tenant . By signing an agreement for another user to take their place in the premises , the original tenant becomes the primary tenant , and the new renter is the subtenant . The subtenant occupies the space and pays all or a portion of the rent owed under the original lease agreement , but the primary tenant is still on the hook financially and legally , with all rights flowing through the primary tenant .
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COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE SPRING 2021