Post-Pandemic Changes that will Affect Your Lease
Predictions of what our “new normal” post-COVID will look like are running rampant these days to the point where it already feels cliché. As much as we’d like to ban the words “unprecedented” and “uncharted” – that is unfortunately the territory we live in now.
While none of us truly know what is to come of this pandemic, there are a few surefire implications for property managers looking out for the safety of their tenants and also, likely, to comply with new regulations set forth by the government in coming months. All of these changes are for the greater good – but all will also result in cost increases. Navigating lease terms and how these costs are passed through, currently and in the future, will be a new sticking-point in the landlord-tenant relationship.
Cleaning and sanitizing services, changes to common area protocol, employee access, operating hours, visitor and guest accommodation, delivery procedures,HVAC modifications and upgrades, and other policies designed to make the environment healthy and safe for the occupants will be increased and/or implemented over the next several months. Gone are the days when the biggest amenity perks are parking and an on-site gym. Now, tenants will want the cleaning schedule and air circulation statistics. While many of these enhancements will be simple and common-sense modifications, all will result in additional costs to the operators, and inevitably, trickle-down to tenants.
It is imperative for tenants to be familiar with existing lease agreements to see the monetary and material impact these changes may have and to understand what degree they are responsible for them – whether it be via direct billing or annual pass throughs of operating expenses.
Fully-serviced leases that provide janitorial services will see an immediate change as Landlords instruct cleaning companies to employ a higher level of cleaning and sanitization. This increase may be voluntary but might also be mandated by state and local authorities. What was included in the scope of work prior to the shutdown? What additional specifications that will be added, and what will the cost increase be? How will requirements and demands for PPE of janitorial staff come to impact these costs? The cleaning component of an operating cost was traditionally between $1.50 to $2.00 per square foot. Where will it benchmark in post-Covid times? For leases with established expense bases this could be very significant. For leases that have yet to establish their base year, this will represent a landlord risk. This new expense will also change building asking rents to reflect the increase in costs.
Building and Tenant insurance packages will also change in response to this crisis, which will result in increased premiums. Tenants pay their pro-rated portion of the building’s insurance in their operating costs and all leases require tenants to carry their own insurance package. This is an increase the Tenant will now pay twice. Both parties are named as additional insureds on the respective policies, and the arrangement allows both the Landlord and Tenant to transfer their respective risks to their insurance carriers. Insurance Companies, being in the business of loss mitigation, will pass this on to the policy holders and costs will increase. Another bump to the operating expense. Leases should be reviewed to see what rights a landlord has regarding the required insurance coverage a tenant must carry, as well as what coverages have been committed to by the Landlord. Tenants and Landlords should be in touch with their insurance professionals to review existing coverages and help estimate future exposure.
Heating and Air Conditioning are always major concerns for tenants and their employees, but that was mostly focused around temperatures and building comfort. Now, air quality and air exchange will be paramount. So paramount, in fact, that we could see mandated changes for construction and occupancy permitting in the near future. The litigation and liability that was created from the “sick building” syndrome could seem minor to the changes that will come from the impact of Coronavirus. Most HVAC systems are designed to American Society of Heating Refrigerating and Air-Conditioning Engineer (ASHRAE) or OSHA standards. There is no doubt that those standards will be upgraded with an emphasis on workplace health and industrial hygiene. New systems or modifications to the existing one will be introduced, and landlords and developers will adopt them. Whether this is caused by government ordinance, fear of liability, or market forces, these changes are coming. HEPA Filters, UV Light, duct sterilization and air purification systems, and air quality monitoring will become building features, if not requirements.
The costs to modify existing systems will be the subject of future debate and negotiation. Is this a capital improvement to be born by the Landlord, is the improvement a compliance with law, or an operating cost to be recovered as a pass-through? A thorough review of the lease will help to dictate how this cost is appropriated.
Building staff is traditionally passed through as an operating cost of the building. Professional staff can make or break an office experience. Class A tenants expect Class A service. Tenants want and expect the building staff to be well trained and familiar with the operation of the facility. The COVID-19 crisis will require initial and ongoing training to deal with new operating standards and most likely additional staff or vendors will be employed to provide this higher level of service. In any event this will represent an additional operating cost.
Buildings could potentially place controls or additional security for guests, visitors, vendors, deliveries, etc. Day cleaning and building porters may make a comeback. The great tenant amenities that are now offered in Class A properties may require new or higher charges for cleaning and sanitation. The costs of additional service will have to be addressed and passed through in some fashion.
Tenants should start preparing for change, as it is certainly coming. The nature of all leasehold occupancy is based on the Landlord providing a service and transferring that risk and cost to the Tenant. Every clause in a lease represents an expense, a right, a liability, or a responsibility, and your firm should be aware of what to expect based on this document. Now is the perfect time to review past operation costs against your lease operating clauses and examine areas of exposure moving forward. All firms need to enhance the health and safety of their employees, but they also need to keep an eye on the bottom line and get the most utility for their office expense. Your lease is the contract that allows your landlord to address these costs, and savvy tenants must be aware of the responsibilities and limits of the Landlord.
Is your organization prepared for these impacts? Are you comfortable in your understanding of your lease? If your answer to either of those questions is hazy – now is a great time to schedule a call with a trusted real estate advisor to review your lease and to highlight the areas that may cause concern. While this may seem less-than-secondary to your daily business operations – the implications to your bottom line merit the extra attention in a time like this.