Blog June 11, 2021

The evolution of real estate leases

By Tom Price

Organizations that occupy real estate have faced many challenges over the past year. In particular, the spotlight on the relationship between tenant and landlord/agent has intensified – with a greater-than-ever need for clear communication and collaboration. Regardless of sector, the way in which businesses provide services, sell goods and interact with their customers and employees has changed, and many of these changes are here to stay.

The future of leases

Real estate lease agreements as we know them have evolved during the last 12 months, with the introduction of new clauses, increased scenario coverage, more options available, and a shift towards turnover-based structures. The very nature of negotiations over the life cycle of the lease are therefore becoming increasingly key to the long-term profitability of a business, in terms of driving down costs and reducing the extent of obligations.

Occupiers have naturally moved to explore and push for more flexibility within lease agreements to accommodate a rise in scenarios such as underutilized office space due to employees working from home, and account for space that perhaps cannot be legally utilized due to COVID restrictions. Occupiers may become more reluctant to signing up to long-term lease agreements based on fixed space, instead there could be more of a movement to demand more defined types of space around temporary or flexible areas with differing options and unit costs. It begs the question; will we see more short-term leases forming part of occupier real estate strategy? The added attraction of this approach of course is that those short-term solutions often do not require inclusion on financial statements and lease accounting schedules, which may act as an additional driver.

The introduction of COVID-type clauses brings a whole new dynamic to real estate lease negotiations and management. These clauses can vary significantly depending on country, region or property use; however, there have been such scenarios recently of termination options made available to the occupier linked to financial stability of the business based on COVID factors, as well as mutual terminations and break options linked to COVID or pandemic-related scenarios.

Many MRI occupier clients have proactively moved to renegotiate and re-gear leases on mass to agree a more sustainable commercial model, whether that be concessions, deferrals or a change in payment frequency. Recently, particularly in the UK, occupiers have sought to renegotiate quarterly rent payments to monthly, more akin to the US leasing model – spreading the risk thanks to smaller periodic payments. The impact this can have on reporting and internal processes means technology alignment is particularly significant if this negotiation covers a large and complex portfolio.

New lease variables

As the impact of the pandemic forces occupiers to re-evaluate the structure of leases, it’s bringing to the fore other questions and trends around how real estate agreements are put together. Take sustainability, a hot topic in many walks of life, and none more so than sustainability within the property sector. ESG clauses are increasingly being imposed within lease agreements to enable landlords to more accurately track progress on ESG initiatives, which naturally require the occupier’s permission. This is placing responsibility on an occupier to now share sustainability data for more of a detailed indication to the landlord of the premises being a “green building.” We are seeing this become a common requirement within the market where occupier organizations have a need to understand much more than their financial obligations, and now have a potential legal obligation from a sustainability perspective across their portfolio of lease agreements, which we anticipate could have a consequence when negotiating any sublease agreements, too.

For retailer occupiers, we are also seeing an increased movement towards desirable turnover rent based agreements with landlords, with many landlords also proactively presenting a regearing of the lease to restructure the agreement. This model creates a more interdependent relationship between landlord and occupier and is aimed at benefiting both parties. This is evidently a more attractive proposal for when times become tough as we have seen during the pandemic, where stores out of the occupier’s control are legally required to stop trading.

Role of technology

In the same way that there has been a natural evolution to single source of truth; i.e., a single lease record driving all payments, lease accounting schedules, key event alerts, etc., there is now a movement toward Artificial Intelligence-powered occupier management.

For a sector that has been notoriously slow to adapt to change and adopt technology, the pace at which real estate lease structures are evolving demands a faster movement toward innovation and automation. Many occupier technology procurement processes are no longer simply looking at functional requirements around key business processes, but are instead conducting deep evaluations of how best to maximize the integrity and auditability of real estate and lease data, to provide confidence in the data held within systems not just at the point of go-live, but on an ongoing basis. To be able to leverage lease data confidently, to rely on auditable data to inform strategic decisions, to have visibility of the obligations across the portfolio, to identify key clauses and options directly linked to opportunities to drive down costs, are all of paramount importance. The introduction of AI to real estate and integration with core real estate management applications is a game changer, with the ability to move away from manual, time-consuming, error-prone data entry methods and instead leverage clean, structured, and complete data captured at source from lease contracts. With leases becoming more complex, technology needs to be robust, flexible, and scalable. We have seen more and more organizations incorporate additional departments like legal, along with senior stakeholder involvement as part of a procurement process, often with a project steerco, given real estate now has more of a seat of influence at c-suite level than perhaps ever before.

As a whole, customer and employee habits look likely to continue changing, lease agreement structures are evolving and becoming far more sophisticated and far reaching, new trends across occupier requirements are developing, and technology’s role in supporting and underpinning real estate strategy will continue to become more prominent over the coming months and years as the occupier space becomes more complex. It’s therefore absolutely key to the long-term vision of occupier organizations to fully understand their obligations beyond financials in order to leverage their portfolio, and technology will be fundamental to successfully doing so.

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