COVID-19 has already impacted the market for leased real estate and companies’ plans for leasing. In fact, 30 percent of 109 respondents to a recent survey conducted by Compliance Week and Visual Lease indicated more than 75 percent of their leased real estate properties were unoccupied due to the coronavirus pandemic and more than 60 percent said they plan to change their approach to leasing business assets.
“We are all living with the impacts of COVID-19, and no one really knows when things will improve,” Visual Lease Founder and CEO Marc Betesh said. “The market response is a lot of vacancies. Leases are in place, but space is not occupied. We are all hoping there will be some semblance of normalcy by this fall.”
What percentage of your company’s leased real estate properties are unoccupied due to COVID-9?
Forty percent of respondents indicating that more than half of their leased real estate is not occupied reflects the new reality of more people working from home and turning to technology at an accelerated rate. “I believe the market for office space overall will contract 8-10 percent, which is a huge number, mostly due to people working remotely,” Betesh said. “But then it should stabilize in 6-9 months.”
Betesh expects more of a decline in demand in bigger cities, with an increase in the suburbs as companies migrate to smaller locations closer to employees’ homes to save money and reduce commuting. Retail will likely suffer more than office space.
Has your company paid rent on your unoccupied properties?
Of respondents who indicated more than 50 percent of their leased real estate was unoccupied due to COVID-19, 63 percent said they continued to pay all of their rent. Betesh was a bit surprised the number was that low, since leases are a legal contractual obligation.
“I wouldn’t expect landlords to approach tenants right now under these difficult circumstances, even though they are under tremendous pressure to pay mortgages and loans,” he said. In fact, 17 percent of respondents indicated their landlords approached them to offer rent relief. “As a result of deferred rent arrangements, I actually expect the number of tenants paying their rent is actually higher than 63 percent,” Betesh said.
Have you, or do you plan to ask for any concessions for your commercial leases from service providers or landlords due to the impact of COVID-19?
More than 50 percent of respondents asked for concessions and received various forms of them.
“A lot of tenants are straining economically, looking for cash flow and ways to reduce or defer expenses, and rent is one of the biggest expense items other than personnel for most companies,” Betesh said. The majority of concessions requested by survey respondents were rent deferrals (18 percent) or reductions (16 percent). Only eight respondents indicated they received abatements, and most of those were for 120 days or less.
In response to the number of lease concessions as a result of COVID-19, the Financial Accounting Standards Board (FASB) issued a Q&A in April that provides relief and changes the existing requirement in the lease accounting standard relating to lease modifications. For concessions related to effects of COVID-19 that do not result in a substantial increase in the lessor’s rights or the lessee’s obligations, companies will not have to analyze each lease contract and can elect to apply or not apply lease modification guidance to those leases.
Given the current economic climate, is your organization planning to change its approach to leasing assets (Choose all that apply).
Although 37 percent of respondents said they had no plans to change their approach to leasing assets, more than 60 percent indicated there would be some change: 31 percent plan to reduce facilities leases, 30 percent plan to reduce commercial office leases, and 23 percent plan to reduce equipment leases.
“The results reflect that office spaces with the largest concentration of people who can work remotely will be the ones most impacted,” Betesh said. “This is a continuation of trends that are already there, as many people are functioning efficiently working remotely now and, even if offices reopen, the need for office space will be less than it was.”
Betesh noted that when people do return to offices there may be a need for less total space as employees continue to work from home, but social distancing requires more area per employee and more collaboration and meeting space so the net impact on leased space is unknown. There may also be a reduction in demand for city space with a high concentration of offices, with an increase in dispersed smaller suburban offices each holding fewer people.
Betesh does not expect adoption of the new lease accounting standard to change companies’ behavior or drive lease transactions, which will be driven by business needs and cash flows. “They will lease space if they need space and buy buildings if they need to control the asset,” he said. He believes there may be some changes in lease versus buy decisions for non-real estate assets as a result of having to present the full-term lease liability on the balance sheet.
Has the shift to a remote workforce made you reconsider your leases/plans to get out of leases and go full or partially remote?
While only 6 percent of respondents said they plan to go fully to working remotely post-pandemic, 57 percent intend to remain partially remote. Betesh believes this has significant implications for and puts a big strain on companies’ IT and HR departments.
“Every aspect of work needs to be accommodated, and the right balance between collaborative and independent work needs to be found for each organization depending on the nature of the work,” Betesh says. “It also changes where employees work, which gives companies the opportunity to hire from anywhere in the country or the world,” he adds. This provides potentially better talent at reduced costs, but it can also increase the risk of employees leaving to seek new opportunities outside their companies.
How confident are you that you have enough information to inform your COVID-19-related legal, operational, and financial operations?
Most respondents said they were confident in making COVID-19-related legal, operational, and financial decisions, with 61 percent indicating they were “somewhat confident” and 30 percent “very confident.”
“People think they have enough information but will be surprised by the myriad of new issues they will face,” Betesh warned.
He recommends companies focus on their business operations and what makes them effective and not do things that undermine their position in the marketplace. “Most companies’ results are suffering in some way, so they must identify cost savings and find new revenue opportunities,” he said.
This includes optimizing their infrastructure and leases. “Companies need to look at their leases and the benefits they have negotiated and make sure they are paying what they are supposed to be paying,” Betesh recommended. “Most leases have 20 financial terms other than the rent, but most people don’t understand this and only look at the lease terms after the initial negotiation if they have a problem.”
What clauses in your leases are you evaluating for potential cost savings? Select all that apply.
About 63 percent of respondents indicated they were evaluating options in leases for potential cost savings. “Options are very important to negotiate in new leases,” Betesh said. He also advises companies to be careful to monitor dates for exercising options in existing leases, so they don’t miss opportunities and then have to renegotiate them in the current market.
Betesh recommends companies consider both macro and micro issues. In his experience, there can be significant missed cost savings opportunities from the failure to take a macro approach and communicate throughout the organization, like consolidating space. “What I always found important as an advisor was the need to get your arms around your lease portfolio to make decisions on a macro level,” he said. “Leases are all different. What are the standard key things you need to know about all of your leases? What is meaningful to you?” At the micro level, he recommends looking at controlling lease costs for items other than rent, such as operating costs and taxes. “These can be more complex, but you must control them or they can cost as much as the rent.”
In regard to the implementation of FASB’s new lease accounting standard and ASU 2020-05, which deferred the effective date of Topic 842 for an additional year to 2022 for non-public companies and public companies that have not yet adopted it, Betesh said: “FASB provided more time due to COVID-19 because companies are focusing on their operations and staying in business right now, not lease accounting. Some companies think a reprieve is free time but to avoid a big crunch later, lease accounting implementation should keep moving because of how long it takes to adopt.”
He notes the skills and resources needed and the time it takes to read and account for each lease and all its amendments.
“Facilities-oriented systems are out there to manage leased physical space and the financial and legal lease terms. There are some tools for basic accounting for leases that don’t manage leases, but there aren’t many tools out there to both manage and account for leases,” he said. “Companies really need a comprehensive tool to control leases overall.”
He advises the new standard is causing a big shift in how CFOs think about lease management within their organizations. “Corporate real estate management over the past several decades has largely been a function of physical space and managing the facilities. There hadn’t been a heavy focus by CFOs about the legal and accounting side of leases,” he said. “Now that leases are reported on the balance sheet and have become an integral part of the financial statements, CFOs are getting involved. They are realizing leases are big dollar contracts that may not have been reviewed and approved before like other significant contracts, and now they are waking up to their huge exposures and shifting their focus and resources to better manage them.”