Two years of economic uncertainty have repeatedly hindered commercial brokerage as each new variant of COVID-19 emptied office buildings and reduced store hours. Commercial real estate temporarily fizzled as business owners waited for the world to reopen again. The pandemic-driven trend of negative absorption persisted, with offices in the U.S. only shifting to positive net absorption within the last quarter, according to JLL. Leases also became more complicated as tenants used their newfound leverage to demand concessions like enhanced build-out allowances and spatial flexibility.
A boost in free rent was the most common pandemic lease concession offered by landlords to incentivize new tenants into renting space or negotiating a renewal. Free-rent concessions when the pandemic first struck, as far as offices were concerned, went up by 30 percent compared to 2019, according to CompStak, an analytics platform that uses a crowd-sourced model to gather real estate data. Furthermore, the average number of months in which office landlords in particular offered free rent in the second quarter of 2021 was 4.6, a stark increase from roughly 3.5 months in the same quarter in 2019.
Now, no landlord wants to seem that they’re desperate but there is a lot more at stake than just losing leverage in a negotiation. Buildings are valued based on a multiple of their revenue, so a drop in rental rates has a powerful negative effect on the building’s market value. One creative solution that landlords are using to offset the perceived loss on a given commercial property was to delay the commencement date of their leases.
The commencement date, the date where the lease begins, is not the same as the execution date, the date when both parties sign the lease. If the landlord and the tenant cannot sign their lease on the same day, then the date where the last party member signs is deemed the execution date. Then, there is the rent commencement date, which is when the monthly rent for the leased space begins. Now, the rent commencement date is not exactly the same as the commencement date because the tenant may have concessions from the landlord that include a period of free rent. The rent commencement date may take place months after the commencement date of the lease agreement. So, a lease could be signed on January 1st, technically begin on April 1st, but the tenant would only start paying rent on August 1st.
So, if landlords were already offering a few months of free rent, which would take place after the commencement date, why delay the commencement date from the execution date? Well, the short answer is that pushing the commencement date further down the line from the execution date makes it look as if the landlord didn’t give away as much free rent as they did. “Delaying the commencement date effectively led to more free rent for tenants,” said Michael Mandel, co-founder and CEO of CompStak, “but the difference is that it wasn’t technically free rent because you couldn’t occupy the space just yet. The delayed commencement date was effectively delaying the start of the lease.” At the height of the pandemic, the delay in commencement had stretched to a high of 130 days in the third quarter of 2021, according to CompStak’s data. This extension, an exclusive product of the pandemic, allowed tenants to lock in their rent rate for when their rent commencement date would begin without having to start the clock on a lease for space they didn’t yet need.
The delineation is important because “free rent” indicates that you can occupy the space but don’t pay for it. “This is a situation where you don’t have a need to occupy it, and so, the benefit for the landlord delaying the commencement date is that it makes it look like they didn’t give as much free rent,” continued Mandel. The concession was also beneficial for the tenant, as each wave of COVID-19 postponed office openings and extended ongoing lockdowns. Many tenants were reasonably confident that they would eventually need the space once the virus waned but also recognized that they wouldn’t need it immediately so this was a good option for many occupiers.
Offering more tenant concessions in a low-demand market is a double-edged sword for landlords. On the one hand, the landlords need tenants to rent out their space. On the other hand, trying to woo prospective tenants by showering them with incentives threatens the facade that the landlord’s building isn’t doing as well as other buildings on the market. Suppose landlords had kept the commencement date early, without pushing it back from the execution date. In that case, they’d effectively be giving more free rent and be increasing the value of concessions they gave, which could undermine the property. “By delaying the commencement date,” Mandel explained, “landlords can keep their concessions lower and make it look like they weren’t as desperate as they were.”
While we all hope that COVID-19 will soon vanish into nothing but a memory of a bygone era, some of the pandemic’s contractual provisions may continue to infect commercial leases for the foreseeable future. Things like force majeure clauses have been rewritten to factor epidemics and pandemics. An increase in free rent is still a trend that continues today. As far as the increase in commencement delays, Mandel is unsure how long the fad will continue. “It’s pretty interesting, although I doubt it will continue,” before wistfully adding, “but maybe it will.”