July 28, 2020

An Inside Look at Commercial Leasing Trends & Legal Analysis | Featured on PropertyShark

The commercial real estate industry is facing uncertain times ahead in a post-COVID world, and industry professionals are wondering what’s next and how they can prepare for a new normal. To find out, Nataly Goldstein, the leading real estate attorney at PN, spoke with Yaron Cohen, founder of commercial leasing agency Leviathan Leasing, to discuss current commercial leasing trends and potential legal changes to come.

Q: What is your background in real estate?

Cohen: My real estate background really starts from childhood; my family business is real estate, so I was thrown into the business at a young age. At the minimum age requirement of 18 years, I got my salesperson license and began renting residential apartments throughout the five boroughs. From there, I began developing relationships with landlords and a rapport with tenants to gain a handful of exclusive rentals. I quickly made my way into commercial leasing, which has been my focus ever since and led me to begin my own company, Leviathan Leasing.

Q: What trends have you have noticed lately in the commercial real estate business?

Cohen: It’s been interesting to see the commercial market fluctuate in the past three to four years with a decrease in brick-and-mortar stores due to online shopping. But, this pandemic has definitely changed the market. Regardless, I do believe that New York City will always be an active community and that is what’s keeping me in the real estate industry.

One trend, in particular, is that tenants are more willing to open up their books and negotiate percentage leasing or income-based rent. Percentage leasing is a type of lease where the tenant pays a base minimum rent in addition to a portion of the tenant’s gross income – the percentage of sales that the store gains.

This is not hitting the market heavily today, but as tenants become more educated, they may use it to their benefit by negotiating a more conservative lease. We’ve definitely had a few clients discuss this option.

Another trend we are seeing is shorter-term leases. Generally, a commercial lease term will run anywhere from 5 to 30 years or so. Today, landlords and tenants are trying to be more conservative in unsettling times and are more willing to agree on shorter leases to renegotiate once things have settled. I have even seen one-year leases thus far.

Q: Has there been a shift throughout the pandemic — from March to today?

Cohen: In March and April, we definitely saw tenants’ mentality change a bit, but closings are still happening. Some tenants — mostly smaller, mom-and-pop shops roughly under 1,500 square feet — had their eye on the ball and knew the industry would pick up again, so they began negotiations with their landlords right away. Other, larger-name tenants have higher exposure and higher risk, so they typically renegotiated before signing new leases or backed out altogether.

One big change that we’ve been seeing is with national tenants. National tenants are multi-state businesses, such as franchises (Starbucks, CVS, Walgreens) that occupy larger spaces of roughly over 3,000 square feet. At the start of the pandemic, they knew things were uncertain but thought that they would survive and break through. Today though, those companies are seeing themselves close locations, break current leases and stop any future prospectives they were looking into.

Q: What happens to the leases when locations close? 

Goldstein: With commercial leases, there is nothing that would allow a tenant to just get out of a lease for no reason or for a reason specific to something like this pandemic. In general contracts, we have what’s called a force majeure clause, which could be included in a commercial lease.

Force majeure clauses basically state that if there is some kind of act of God (for example, natural disasters), then either of the parties in this contract can get out of performing their part of the agreement. But what does that mean, exactly?

First of all, force majeures are interpreted by judges very specifically. Most force majeures refer to an act of god, which sounds broad, but what it really means is a flood, a hurricane – an occurrence that no one can control, in the hands of God.

In such cases, for example the major flooding brought on by Hurricane Sandy in 2012, where landlords couldn’t allow tenants to come into their spaces anymore, the landlords would not have any repercussions because it was a natural act of God that forced the landlord to be in this situation. So, a tenant was not able to sue the landlord for not allowing them to enter the premises.

In our current situation, that is not the case. Even though this pandemic is in some ways a natural disaster, the real consequence to COVID-19 has been that everyone has been under quarantine, which was a government-enacted force. It is the government that is enforcing stay-at-home orders, so that does not fit in this act of God description, unless otherwise expressed in the contract.

So, if a commercial lease included a clause about government enforcements (which I have seen in the past), they could be covered under force majeure. Many leases do not currently have a clause like this in place, but I am sure we will begin seeing that added in for the future.

All in all, there is nothing in a standard New York commercial lease that could allow a tenant or landlord to get out of their lease based on the pandemic that’s going on.

Cohen: To add on to that, we have been seeing what industry professionals are calling a coronavirus clause. Essentially, it’s a mutual agreement between landlord and tenant that allows the start of the lease to depend on what phase New York is currently in. For example, we are working with a gym that is moving into a space in Midtown. They are taking up a short, one-year lease, but the lease will begin as soon as gyms are allowed to open up per New York rules.  

Goldstein: So, the lease starting date is basically TBD – to be determined.

Cohen: Exactly. As soon as phase four hits and gyms are allowed open back up, that’s when the lease will start.

Q: Have you noticed any points of tension between landlords and tenants?

Cohen: I actually think this is a time when tenants and landlords will communicate better than they ever have. From my perspective, both parties have been open-minded and more cooperative with each other because, financially, it makes more sense. Landlords want to avoid extra expenses and hassles, such as broker fees or sitting on vacancies.

Commercial tenants have also invested a lot in their spaces and rely on clientele in their area, so they want to avoid relocating. Again, mom-and-pops have been more willing to work with landlords, while some disputes are arising with larger tenants and spaces.

Goldstein: The trends from consumers is also something to think about. Commercial real estate was on a downward trend concerning retail because of online shopping. Now, during quarantine, everyone realized that they can survive by just shopping online rather than visiting the stores, but they miss the intimate experience of shopping in boutiques.

I believe, after quarantine, we will continue to see a downward trend in larger-retailer shopping, i.e. the national tenants, and might even see a spike in the boutique, customized stores.

Cohen: We’re also seeing new commercial tenants come into the game. So, while some are downsizing, others are picking up additional spaces to take advantage of the low rents. For example, Facebook just shut down their roughly 1-million-square-foot lease (basically 60% of a building), turning a billion-dollar value to a $200 million value. However, TikTok grew from an estimated 4,000-square-foot space to a minimum of 200,000-square-foot space.

So, yes, places will shrink. But we’re also seeing clients with one or two locations saying they are going to expand right now.

Goldstein: Because they see rent is low and landlords are willing to work with them?

Cohen: Because the opportunity is there. I think the retail market will pick up far quicker than offices. Office leasing was booming before COVID-19 (it was in its third-year high starting in 2017), but now people can work from home or a local co-working space. So, office leasing will face an interesting next few months. Vacancies are very high right now and not many people are looking.

Q: What about disputes between landlords and tenants?

Goldstein: The major disconnect here is that there has always been a game between landlords and tenants. The tenant views the landlord as a financially secure individual and if they lose one- to two-months of rent, they’re not necessarily losing anything because they have other tenants paying.

But now, there are multiple commercial tenants in a building not paying rent and the landlord still has the responsibility to pay the mortgage, which is crucial to both the landlord and tenant’s survival.

A major note in commercial leases is that the tenant typically has to pay for their portion of real estate taxes, maintenance, etc.: this is called CAM. Generally, if a tenant does not pay their base rent, they will try to still pay CAM charges to maintain the building. Today, no one is paying CAM or rent, and the landlord still has to maintain the building and mortgage.

So, that’s a major disconnect here and is the reason why tenants feel that they have the upper hand right now — because the landlord is in a desperate position where they still have expenses, but little money coming in.

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