Commercial landlords in Canada are feeling the pinch. Last quarter, the country’s office vacancy rate climbed to 18.1%, its highest level in nearly 30 years, according to the CBRE.
A post-COVID shift to remote and hybrid work has drastically impacted the commercial real estate market, especially when it comes to leasing.
This decrease in demand, combined with rising interest rates, has put commercial landlords in a tough spot. But it’s also created a tenant market, putting would-be renters in a stronger bargaining position due to high vacancy rates.
We’ve looked at how prospective and existing commercial tenants can take advantage of these market conditions, and what landlords can do to weather the uncertainty of the commercial leasing market.
The changing trends in commercial leasing
A lease is a large expense on the balance sheet for most businesses, so many owners currently looking to rent office space are taking a more conservative approach. We’re seeing more leases for smaller spaces and very few for sprawling 100,000-square-foot offices.
We’re also seeing tenants become more creative with the space they lease, especially in the tech sector, where owners are looking for complementary businesses to co-share their space through a sublease. Sharing offices allows business owners to reduce their monthly overhead costs and also collaborate with like-minded organizations.
Commercial landlords offering more flexibility in lease terms
Given the high vacancy rates in office buildings, especially in the downtown areas of major cities, many commercial landlords are taking a more cooperative approach when it comes to drawing up the terms of the rental agreement.
And it’s not just large anchor clients who are able to negotiate these favourable terms – smaller businesses and start-ups also have increased bargaining power in today’s market.
With this economic uncertainty, tenants are able to get favourable terms, including shorter lease agreements with extension options. These options give tenants flexibility while negotiating options to extend their lease, allowing the tenant to evaluate their leasing needs in 3-5 years. They can also negotiate for early termination, the right to give up space and include accommodations for subleasing provisions.
For tenants, it’s important to note that while short-term leases can help reduce financial commitment, it also means rate uncertainty when your renewal comes around, compared to the fixed rate of a long-term lease.
Demolition provisions in lease agreements
Affordable housing is a significant issue across Canada at the moment, and one of the proposed solutions is converting unused office space into residential properties.
These renovation projects are already underway in Halifax, and Calgary, and are being discussed in other cities like Toronto, London, and Yellowknife. In fact, there’s even government funding available to help pay for these office conversions.
The growth of these conversion projects means that commercial landlords often include demolition provisions in their contracts. These clauses allow them to sever a commercial agreement within a specified notice period.
This provision is advantageous to landlords who own commercial property in a prime location because, at any time, they may be tapped on the shoulder by a developer interested in their property, and this clause enables them to legally remove tenants before they sell the land.
If a commercial property has already been sold to a developer, it can also be an excellent opportunity for tenants who may be able to get a deal on a short-term lease.
Pop-up businesses are becoming an increasingly popular way for both tenants and landlords to take advantage of these short lease windows. It’s an ideal opportunity for a business owner who wants to test out their idea in a specific market without having to commit to a long-term lease, and it’s great for landlords who are able to earn rental income before their property changes hands.
The importance of negotiating during the offer to lease stage
The offer-to-lease (OTL) stage is one the most important stages in the commercial leasing process. It’s the first step of negotiation between the landlord and the tenant.
However, oftentimes, tenants don’t get a lawyer involved in negotiations until the lease agreement stage (which comes after the OTL). But this approach puts tenants in a less favourable bargaining position and makes it difficult to negotiate certain concessions in the lease.
Negotiating your terms as a tenant during the OTL stage gives you more bargaining power because you have a motivated landlord, and you are not yet committed to the space. Once you have signed the OTL, you have a binding contract with the landlord even though you have not yet finalized your lease.
However, if you sign the OTL without negotiating the terms, that’s a binding agreement and means you’ve agreed to take on the space based on the financial terms set out in the contract.
That’s why it’s so crucial for tenants to get their lawyer involved as soon as possible in the lease agreement process to help negotiate the most favourable terms.
Key terms to consider during the offer-to-lease stage
If you’re a landlord looking to lease your property, you’ll want to ensure you have provisions in your contract at the OTL stage that give you flexibility in the event of demolition, relocation or a sale.
If you’re a tenant looking to lease a commercial property, it’s important to understand the full scope of your financial obligations at the OTL stage. On top of your monthly lease payments, are there other rental fees, property fees or operational charges you will be required to pay? If it’s an older building, who is responsible for maintenance, upkeep and repairs on expensive items like the HVAC systems or a new roof?
If you want to sublease the property, what are the transfer provisions and what triggers them? Does the landlord need to give their approval for any new subtenant? It’s important tenants understand the risks of subleasing (damage, non-payment, etc., by subtenants) as well.
Get expert help with commercial leasing
If you’re considering leasing a commercial space as a tenant or buying a commercial property as a landlord, we can help. Caravel has a team of over 90 qualified and experienced lawyers, including those specializing in commercial real estate and leasing, who can support you through the process. Get in touch with our team today to find out more.