Commercial real estate began undergoing significant changes prior to 2020, and those changes were accelerated and exacerbated by the COVID-19 pandemic. There is not a single category or class of commercial real estate that has not been affected. On the heels of the health crisis came market volatility, the prospect of a looming recession, inflation and rising interest rates—all of which, combined with national and international geopolitical issues, have thrust the U.S. economy into uncharted territory. The brightest of the bright spots for commercial real estate is that multi-family apartment buildings and complexes appear to be continuing to grow both in urban and suburban markets, and industrial property continues to be a hot commodity as e-commerce continues to grow in the effort to get products into consumers’ hands more quickly.
No one has said that office space is dead or on life support, but it does appear that many tenants and users of office space are reevaluating and reconsidering their needs."
Despite the bright spots, however, there appears to be a dark cloud over office properties. No one has said that office space is dead or on life support, but it does appear that many tenants and users of office space are reevaluating and reconsidering their needs—the results of which may leave landlords and tenants wondering what options they have to satisfy their current needs. It's widely acknowledged and accepted that the COVID-19-mandated quarantines and shutdowns forced employers and employees to adapt and utilize a remote working environment, and employees refuted the prior perception that remote employees were not as productive as in-person. Additionally, because employees no longer needed to be in the same city or state as their office, many employees elected to move to a place of their choosing and continue to work remotely for their current employer. When the quarantines and shutdowns ended, it seemed clear that employees preferred to continue to work remotely rather than in an office. The majority of employers that decided to bring employees back to the office began doing so with hybrid working environments that allow employees to work remotely a certain number of days a week and be in-person in the office the remaining days.
The consequence of this is that many companies no longer need the same amount of office space that they required pre-pandemic. For many employers, the number of people going to the office has been significantly reduced, and for others, they have adopted "hoteling" arrangements where employees can share workstations/offices and rotate in-person days to avoid overcrowding. This has led employers who also face inflation and increased overhead generally, including increased employee wages and utility bills, to wonder how to cut back—including how to reduce expenses and give up some of their office space. This can be done a number of different ways depending on the terms of each lease. Some leases may have an express option allowing the tenant to reduce the size of the premises (which is not common). Those leases that do not have this option can still accomplish this end by modifying the lease (usually would involve giving some added value to the landlord, such as agreeing to an early exercise of a renewal option or extending the current term of the lease in exchange for a reduction in the size of the premises), partially assigning the lease or subletting a portion of the premises.
Most commercial office leases allow partial assignments and subleases only with the consent of the landlord—so the initial step for tenants is to have a conversation with the landlord, explain the circumstances and try to reach an agreement that will allow the tenant to market a portion of the space for a partial assignment or subletting. Once consent is obtained, and an assignee or subtenant is found, there are still legal and practical considerations that need to be addressed. Among them is the legal documentation, the partial assignment/assumption of lease or the sublease—each of which can be complex and. if not done properly, have dire consequences. Some of the concerns the parties will have with either of these scenarios are liability under the lease (both historic and prospective—in either scenario, there are possibilities that may make each party liable for the actions or inactions of the other) and separately demising the assigned/sublet space (including constructing interior demising/partition walls, providing access, restrooms and kitchen facilities and, if applicable, providing for separately metered utilities to each space). Exploring these options requires a carefully selected team of professionals, including brokers, architects and attorneys, to examine these issues and develop a solution that minimizes risk.
Landlords are left with the prospect of increasing vacancy rates in their office buildings and potentially not many, if any, new occupants. Among the options being considered by landlords are (i) offering more tenant incentives to attract new occupants and (ii) repurposing the vacant office space for a new use—such as converting empty office buildings (or portions of office buildings) into multi-family apartments. Converting entire or portions of office buildings into multi-family comes with its own laundry list of potential challenges, not least among which is that conversion of the office into multi-family requires significant capital. Some other concerns include permitted uses under current zoning regulations, satisfying parking requirements (both legally and practically) for both office and multi-family users, and being able to provide amenities that will attract and retain tenants. Other issues for partial conversions involve physically separating the multi-family space from the office space and, more importantly, separating the legal structure and expenses for the multi-family portion of the building from the office portion of the building.
Whether you are a tenant or landlord of commercial office space, if you haven’t done so already, you should be examining the current and future status of your lease(s) and exploring what options may be available to you given your current and anticipated circumstances—and start preparing for them. There are many questions and considerations in addition to what is generally described above that vary depending on your specific circumstances as well as the type of lease space and/or building. All of these questions and considerations are important and must be reviewed carefully and understood before formulating and implementing a plan moving forward. To start, you should consider hiring a lawyer and law firm that is experienced and knowledgeable with these types of situations and circumstances.
Brion J. Kirsch is an attorney at Pullman & Comley, LLC in Hartford, Connecticut. He is co-chair of the firm’s Real Estate, Energy, Environmental and Land Use Practice and a member of the firm’s Commercial Finance Practice. Brion is listed in The Best Lawyers in America® in the area of Real Estate Law for 2023.
