How can tenants prepare themselves for a declining office market in the future?
With the bullish mood in the real estate market over the past three years and an increasingly positive economic outlook, it's easy to forget that the office market struggled until 2016. Even with current sharply changing stock prices and plummeting oil prices due to the Corona virus, we do not expect the economy to reverse for the time being. But everything comes to an end. That is why we have listed a number of measures that a sensible office tenant should take into account to withstand a cyclical turnaround.
After years of economic downturn, many organisations have found the way forward again. Cost-cutting programmes have made way for growth strategies. War for talent has become the new adage. To bind that talent, the best offices must be rented and furnished as real living rooms with chill corners.
Because little to nothing was added in the ‘bad years’ and a lot of office space has been transformed into, for example, housing, a run has started on the better office buildings since the economy has picked up. Various brokerage organisations are now sounding the alarm, because in the big cities it is barely possible to rent good office space. If you want to rent office space with which you can satisfy your new talents, you will be competing with other companies. Under that pressure, it is still wise to consider the aspects below when negotiating – for when there is an economic recession and the time has come to cut costs again.
1. Contraction options in rental agreements
As unlikely as it may sound, now is the time to negotiate contraction and break options in rental agreements. Even if this is accompanied by a pre-agreed fee, it is often cheaper than the consequences of having to rent excess office space for years at a price from ‘better times’.
2. The tenant’s option
Another option for building in flexibility is the tenant’s option. It is worth considering agreeing on a shorter lease term, with one or more tenant options. This means that at the end of a rental period, only the tenant may terminate. As tenant you have the certainty to be able to continue renting the office for a longer period, but there are possibilities as a tenant to terminate earlier.
3. Market rent review clause
Do you expect rents to fall at the end of the first or second period? Then it might be a good idea to include a clause now that the rent can be adjusted to the market rent level at that time. By including an article in the lease for a formal market rent review, you already have a tightly defined process in advance to arrive at a revised rental.
4. Spread incentives over the rental term
Insofar as incentives still exist, there is the choice to include these as the “rent-free period” in the first months of the lease or to have them paid out in the form of a spread rental discount. During the financial crisis, the latter option was particularly popular among landlords who were afraid to provide rent-free periods at the start of a lease and see the tenant go bankrupt shortly after. The advantage for the tenant can be that if the economy slows down, the rental costs for the entire rental period are already at a realistic level.
5. Limit the rental term
In times of prosperity, it is very tempting for landlords to enforce rental agreements of, for example, ten years. For most companies, it is difficult to predict what the business will do in the next 12 months. Let alone in ten years. Leases for longer than five or six years are therefore only recommended if you are almost 100% sure that you really need that space for that long, and completely. In the long run, it is almost always cheaper to pay a slightly higher rent for a lease that offers some flexibility. There are, of course, exceptions: renting a new-build project is hardly possible without a long lease. But even in those situations it is advisable to build in flexibility (see # 1).
6. Exclude the ‘keep open’ clause
Standard rental agreements of the Council for Real Estate (ROZ) stipulate that a tenant must use and keep its property fully furnished for the entire duration of the agreement. But what if things are no longer going well and there are simply no more people? Or if branches need to be merged? We therefore recommend excluding the ‘keep open’ obligation in the ROZ agreement. Certainly in a multi-tenant building, this is easy to negotiate, which means that many problems can be avoided if it turns out in the future that the space is simply no longer needed. How unfortunate it can be, is apparent from the 2008 judgment in NSI vs. Ernst & Young (ECLI:NL:RBZUT:2008:BC8393).
It sounds obvious but is often forgotten. Make sure you get permission to sublet the office space or even transfer the lease. Few landlords are reluctant to include the right of subletting in the agreement, provided that a subtenant can be refused on reasonable grounds.
Conclusion & advice
We hope that the next dip will not occur soon. It is however certain that the dip will come again. As tenants, you can be prepared by following these tips. In practice, we see that many of these aspects can be negotiated. For the moment, it does not immediately translate into financial advantage, but as soon as the economic tide changes, these contracts may turn out to be worth gold.