Premise Lease Negotiations

Pandemic Dental Tenancies – What’s Going On?


Ian D. Toms


April 20, 2021

April 20, 2021

Everything, including tenancies, instantly and dramatically pivoted a year ago. You may be wondering, “What’s going on?” The information that follows summarizes changes that have occurred and the current circumstances tenants are facing.

Rental rates

• Retail rental rates are holding at pre-pandemic rates with some hopeful increases in future years aligned with inflationary expectations (2% per annum)
- There are geographic influences: rates in the downtown areas are decreasing while those in the green and growing bedroom/work-at-home communities are increasing.
- There are realty type influences: grocery store-anchored developments are holding value while big box retail plazas are failing due to pandemic shut-downs and intense, permanent e-commerce competition.
- The supply of available retail space is increasing as businesses fail and do not renew their leases. This effect will lead to lower rates over the next two to three years until we reach a new equilibrium.
- Developers have pulled back as the demand for new space is low and as a result, less new space coming on the market.

• Office rental rates are tumbling in the downtown cores, holding steady in mid-town and firm in the small office market in bedroom/work-at-home communities
- Large office buildings with elevator access only are particularly hard-hit; many large firms are finding that their space requirements are less than 25% of pre-pandemic requirements due to work-at-home and as a result, are not renewing lease terms or are subleasing at base rates less than ½ of what they are paying.

• Most landlords
- are not eager to reduce rates as they are reeling from rent-stream interruption pandemic pain.
- will “cut deals” with short-term rent reduction in exchange for long-term commitment.

Ability to negotiate and renegotiate lease terms and conditions

• Right now, landlords are emotionally exhausted and very nervous about the future of their industry as economic circumstances have changed, but their hands are tied by their own leases and the physical unchanging nature of their properties.
• The economic shift to e-commerce has resulted in a shallow tenant pool; the remaining strong tenants are uncertain about their future and reluctant to commit.
• Rental rates are more negotiable now than a year ago, but landlords are very reluctant to reduce rates below that which was being paid last year. Package deals including free rent, improvement allowance, landlord work and gentle rent adjustment are successful in this environment.
• Leasing managers are tired and irritable like all others now. The negotiation leverage position is to work with them; do not harass or “bug” them; it will back-fire.
• It is even more difficult now to delay termination for demolition and/or add options to renew because
- residential real estate values are increasing at a phenomenal rate putting even greater pressure on landlords to re-develop real estate from commercial to residential.
- landlords are even more uncertain about the future now and less likely to commit long-term.
• The commercial lending environment is conservative; deals are being financed, but each deal is being scrutinized much more than a year ago.
• Tenancies are failing and will continue to fail due to the effect of the past year’s lock-downs, emotional exhaustion and e-commerce competition.
• Lease term renewal negotiations and arbitrations are impaired because we can’t value fair market rent because there have been few transactions and these transactions are distressed.

Demographic and Commerce Shift

• The work environment has shifted dramatically and likely, permanently. People are working-at-home in the bedroom communities and spending where they live, rather than commuting and spending away from where they live.
• People who used to live in high-density residential settings close to their office downtown are heading for low-density urban housing and working from home, resulting in vacant and cash-less downtown cores.
• Prices of low-density residential properties in bedroom communities are increasing significantly as the demand increases due to people re-locating from densely populated areas allowing them to work from home and not commute.
• Patients are leaving practices close to their old workplace and joining practices close to home (new workplace). Some urban practices are seeing production increase 20-30% on a year-over-year basis, at the expense of downtown practices.

Premises availability

• Retail rental space
- will become increasingly more available at relatively good rates over the next 2-3 years as more tenants fail or give up, especially in weaker developments and markets. Be selective. There is a reason why the exiting tenant was weak - you do not want to inherit their issues.
- If you are performing well now, think about relocation or expansion, or early renewal now.
• Purchase
There are two markets
- “listed” properties for sale are being dumped as landlords try to stop the bleeding. These are distressed sales and the vendors are aggressively trying to offload their problems. There are few bargains at this time.
- Unlisted or off-market properties are also available. We are finding that privately owned, non-listed properties are selling and worth buying because current owners are nervous about generating inventory, and interest rates are very low creating affordability. If you are considering relocation to owned real estate, the time is now.

The work environment has shifted dramatically and likely, permanently.
Practical tips

1. If you need to make a change or changes in your lease, the time is now. Approach your landlord to negotiate or re-negotiate because you now have a leverage position.
2. Like you, landlords are tired and frayed at this point, don’t bug them. Work with them. We are all in this together.
3. Be honest. If your production has dipped, ask for a reduction in rent, but be prepared to disclose your financial position.
4. Now is the time to look for a new location. Tenants are in distress and failing. Space may not be listed.
5 Don’t expect rental rates to increase much. Do expect e-commerce and e-marketing to increase.
6. Expect term length and termination for re-development to become even more difficult.