Office landlords are facing a new era of compromise over lease flexibility as corporate occupiers rethink their post-pandemic real estate requirements.
Companies will want increasingly accommodating terms under which they can hand back space during the life of a lease, agents have said. Owners may have to accept their demands as part of securing an anchor tenant for a prelet deal – even if there is a risk of some of the space then being vacated.
Law firm Clifford Chance’s prelet of GPE’s 2 Aldermanbury Square, EC2, has shone a light on how complex arrangements are becoming.
Industry experts have said it’s unusual to see quite such a convoluted structure, but Michael Pain, head of the tenant representation team at Carter Jonas, told EG the prelet could be a “textbook case” of where the market is heading and acts as “a really good illustration of the compromise that landlords and tenants will eventually come up with”.
Clifford Chance has agreed to lease the lower ground to 12th floors of the 321,100 sq ft scheme on separate 20-year leases. It has an option to break at year 15 on the entire building, but also options to break at year eight on the fourth floor and year 12 on the fifth floor.
In addition, the firm can hand back the first to fourth floors provided it does so before March 2024 – the building is due to complete in December 2025. The firm will pay £77 per sq ft if no space is handed back and will have 38 months rent-free over the first 15 years – plus an extra three months rent-free if the leases are not broken. GPE declined to discuss the deal. Clifford Chance did not respond to a request for comment.
“It’s very difficult for any business at the moment to predict how many desks it is going to need in the next three, four or five years – the dust has yet to settle with regard to the impact of Covid on the office market,” said Pain. Add to that broader concerns about the macroeconomic outlook, he said, and “occupiers want as much flexibility as they can get away with”.
Landlord vs tenant
This is not to say tenants hold all the power. Supply and demand imbalances in some submarkets will mean landlords have enough interest to pick and choose between tenants, and smaller square footage requirements will typically have less flexibility built into the lease, although here too the need to compete with flexible workspace providers is shifting the structure. But large deals for prelets will take even more negotiation.
“[Occupiers have] got a slightly stronger position with landlords looking to land a decent-sized prelet,” said Ben Thomson, head of tenant representation at BNP Paribas Real Estate. “Yes, the prelet market is relatively strong but landlords are still competing for that.
“Tenants may not have a lot of options but landlords won’t have a lot of tenants to choose from either. It’s quite a thin market, and you would be a very brave landlord to turn away a 200,000 or 300,000 sq ft prelet because you weren’t willing to entertain some of the flexibility they are requesting.”
At law firm Forsters, partner and head of corporate occupiers Glenn Dunn said the “crystal ball gazing” that companies indulge in ahead of a move has been turned on its head by changing post-pandemic working practices and the looming economic downturn.
The question at the heart of the hunt is unchanged – “How big is my business going to be during the term of the lease?” The answer might be very different.
“It used to be, ‘how can I get more space [over the course of a lease]?’” Dunn said. “Now, because of the effect of hybrid working, you don’t want to be locked into too much space and end up with the responsibility to sublet or surrender space.”
Agents point to a reassuringly buoyant leasing market in London this year, although many big names are committing to less space when they move. Clifford Chance’s Aldermanbury Square prelet is a notable downsize from the firm’s soon-to-be-former headquarters in Canary Wharf, E14, where the firm originally leased 1m sq ft.
Carter Jonas’s Q3 London office market review found a number of occupiers are using break options to downsize by 25-35%, “while trading up in terms of quality”.
“A lot of these prelets are not just being driven by the lack of available existing space, they are also being driven by the need for best-in-class,” said Pain.
Landlords such as GPE will hope a focus on quality over quantity will keep anchor names feeling at home.
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Image: GPE
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