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Downsizing Tenants? Here Are Some Options

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Jessica Morina, CAM
Contact Jessica Morina, CAM

Downsizing Tenants? Here Are Some Options

The rise in workplace flexibility is prompting tenants to reconsider their space requirements. Some are choosing to stay put, anticipating that future growth will fill the extra space. Others are reconfiguring their offices to accommodate more meetings, collaboration, and events. Many are looking for upgraded spaces to lure workers back to their desks. Companies committed to offering staff flexibility are cutting back or eliminating space. For landlords, this shift offers both opportunities and challenges. Being prepared with options for tenants can help minimize negative impacts on cash flow. It may even enhance the investment’s health in the long run.

What Are the Options?

 

Sublease

For tenants wanting to relinquish all or part of their space, a sublease is an excellent option. In a sublease, the original tenant leases the space to a new tenant. The original tenant continues to pay the landlord and is still responsible for the lease but their expenses are offset by the rent collected from the subleasing tenant. Often, subleases are set at a discounted rate to alleviate the original tenant’s rent expenses. The advantage of allowing a sublease is that the space remains occupied and rent continues to come in if the original tenant needs some rent relief. Eventually, the new sublease tenant might opt to sign a lease with the landlord once the sublease term ends, eliminating the need to market the space. Be sure that if your leases allow for subleases that it gives the Landlord the option to approve the new tenant, though. You will want to make sure that any new tenant fits well with existing tenants and doesn’t harm your chances of renting future vacant spaces.

End The Lease (WHAT??!!)

In markets with strong rent growth, your current tenant may be under market rent. Connect with a commercial real estate advisor to get a Broker’s Opinion of Value (BOV). This will help determine if you could be getting higher rent than you are currently getting. If the market is strong and new lease rents are higher, you may want to consider allowing your current tenant to end their lease early. This would allow you to rent your space to a new tenant at higher rental rate, increasing your monthly NOI and the value of your property.

Blend and Extend

“Blend and extend” is a strategy where the landlord offers a discounted rate in exchange for the tenant extending their lease term. This could involve a reduced rate for the current space. It can also be an arrangement that allows the tenant to return some space, thereby reducing overhead. Often these negotiations benefit both parties. The tenant reduces their monthly costs and the landlord secures a longer lease commitment. If market conditions allow, the landlord can lease out the returned space at a higher rate, increasing monthly income.

By the Book

Landlords have the option to enforce the original lease terms, requiring tenants to continue paying rent and NNN fees as agreed. This straightforward approach guarantees income continuity for the landlord assuming the tenant can continue to pay. However, the tenant is unlikely to renew, leaving the landlord with a vacancy at some point.

Next Steps

Review the lease to ensure there are no clauses or terms that may interfere with solutions. Do any of your current leases in place give a tenant exclusive trade use: meaning, for example, if they are an esthetician, no other estheticians can be on site?

Double-check the lease rate against the current market rates. It may make sense to let a tenant with an older, below-market lease terminate the lease early. There may be an opportunity to fill the space with a new tenant at a higher lease rate.

Working with an experienced commercial advisor or property manager can help ensure that you come up with the best possible solution. We highly recommend using a commercial property manager on your investment properties. They are constantly in contact with your tenants and often know of a tenant’s needs to downsize before it turns into a potential lease default for non- payment. They’re in tune with the market and can help provide guidance on best ways to move forward when a tenant requests downsizing.

Matt Mellott
Matt Mellott, CCIM/SIOR
Contact Matt

Downsizing Tenants? Here Are Some Options

The rise in workplace flexibility is prompting tenants to reconsider their space requirements. Some are choosing to stay put, anticipating that future growth will fill the extra space. Others are reconfiguring their offices to accommodate more meetings, collaboration, and events. Many are looking for upgraded spaces to lure workers back to their desks. Companies committed to offering staff flexibility are cutting back or eliminating space. For landlords, this shift offers both opportunities and challenges. Being prepared with options for tenants can help minimize negative impacts on cash flow. It may even enhance the investment’s health in the long run.

What Are the Options?

 

Sublease

For tenants wanting to relinquish all or part of their space, a sublease is an excellent option. In a sublease, the original tenant leases the space to a new tenant. The original tenant continues to pay the landlord and is still responsible for the lease but their expenses are offset by the rent collected from the subleasing tenant. Often, subleases are set at a discounted rate to alleviate the original tenant’s rent expenses. The advantage of allowing a sublease is that the space remains occupied and rent continues to come in if the original tenant needs some rent relief. Eventually, the new sublease tenant might opt to sign a lease with the landlord once the sublease term ends, eliminating the need to market the space. Be sure that if your leases allow for subleases that it gives the Landlord the option to approve the new tenant, though. You will want to make sure that any new tenant fits well with existing tenants and doesn’t harm your chances of renting future vacant spaces.

End The Lease (WHAT??!!)

In markets with strong rent growth, your current tenant may be under market rent. Connect with a commercial real estate advisor to get a Broker’s Opinion of Value (BOV). This will help determine if you could be getting higher rent than you are currently getting. If the market is strong and new lease rents are higher, you may want to consider allowing your current tenant to end their lease early. This would allow you to rent your space to a new tenant at higher rental rate, increasing your monthly NOI and the value of your property.

Blend and Extend

“Blend and extend” is a strategy where the landlord offers a discounted rate in exchange for the tenant extending their lease term. This could involve a reduced rate for the current space. It can also be an arrangement that allows the tenant to return some space, thereby reducing overhead. Often these negotiations benefit both parties. The tenant reduces their monthly costs and the landlord secures a longer lease commitment. If market conditions allow, the landlord can lease out the returned space at a higher rate, increasing monthly income.

By the Book

Landlords have the option to enforce the original lease terms, requiring tenants to continue paying rent and NNN fees as agreed. This straightforward approach guarantees income continuity for the landlord assuming the tenant can continue to pay. However, the tenant is unlikely to renew, leaving the landlord with a vacancy at some point.

Next Steps

Review the lease to ensure there are no clauses or terms that may interfere with solutions. Do any of your current leases in place give a tenant exclusive trade use: meaning, for example, if they are an esthetician, no other estheticians can be on site?

Double-check the lease rate against the current market rates. It may make sense to let a tenant with an older, below-market lease terminate the lease early. There may be an opportunity to fill the space with a new tenant at a higher lease rate.

Working with an experienced commercial advisor or property manager can help ensure that you come up with the best possible solution. We highly recommend using a commercial property manager on your investment properties. They are constantly in contact with your tenants and often know of a tenant’s needs to downsize before it turns into a potential lease default for non- payment. They’re in tune with the market and can help provide guidance on best ways to move forward when a tenant requests downsizing.