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London office market braced for impact of WFH

02 October 2020

With the September quarter due earlier this week, landlords across the city will have been looking at levels of rent collection and default, with the June quarter seeing estimates of only 50% of tenants paying rents on time. As working from home continues, businesses will review their options under their lease. The real impact of coronavirus on London’s office market however, has not yet been felt, and job losses and business failures are likely to increase vacancies.

We may start to see the ‘grey wave’ (grey space is the term used to describe office accommodation that is surplus to the needs of the original tenant but where the lease has not yet expired), with a significant number of occupiers looking to downsize and return ‘grey’ secondary space to the market. This may have the effect of exacerbating the two tier market which was emerging between older Grade B and new Grade A space forcing landlords and tenants into competition to let space.

Forced to enter a period of remote working, how we work and where we work will not be the same, and businesses across the country will be reviewing how to use the office and whether it is needed in the short term. For tenants looking to dispose they will need to be well advised on the market and review their lease terms. We discuss the options below.

Tenant break right

The availability of a break clause allowing the tenant to terminate the lease before the end of the term should be checked. The break date should be diarised and the period of notice, method of service and any pre-conditions checked. Any pre-conditions to the break right will need to be strictly observed and failure to do so can render the break invalid. In the current market, landlords will look very closely to see whether the break right has been properly exercised. Advice should be taken in good time. Exercise of break right does not release the tenant from the lease obligations and the tenant will need to negotiate its dilapidations liability or carry out works to bring the property up to the required standard and reinstate alterations (if required by the landlord).

Assignment

Assignment is the process of transferring the lease to another party (the assignee). Landlord’s consent will be required and typically allow the landlord to impose conditions as part of giving its approval for the assignment, the proposed assignee will need to meet financial tests and may need to provide security to the landlord. The outgoing tenant will usually be required to enter into an Authorised Guarantee Agreement (AGA) with the landlord, guaranteeing the incoming tenant’s obligations under the lease until the end of the lease term or a further assignment to new assignee. Under some older leases, the outgoing tenant can remain liable for the remainder of the lease term (though these are less common).

Assigning may require a reverse premium to be paid by the outgoing tenant to the assignee in order to incentivise them to take an assignment of the lease. This will depend on the marketability of the premises, the rent payable under the lease, its state and condition, and quality of its fit-out (which will determine the incoming tenants likely capital spend for its occupation).

Sub-letting

Sub-letting the whole or part of the premises may also be an option, again landlord’s consent will be required and the lease should be checked for any conditions that need to be satisfied. The lease is likely to require the sub-letting to be at open market rent, but more onerous leases may require the sub-let rent not to be lower than the main lease rent, which can prevent sub-letting in a falling market.

The tenant will continue to remain liable under its own lease to its landlord for all of the obligations including the requirement to pay rent.

Surrender

A further option available to tenants is to negotiate a surrender with its landlord. This is a negotiated termination of the lease, outside of the terms of the lease. Whether the landlord is agreeable to a surrender is likely to depend upon how easily the premises can be re-let or whether it has plans to redevelop. Often, as part of the agreement to surrender a premises, a landlord will wish to be compensated for breaches of the tenant covenants in the lease relating to repair and condition. The payment of a premium to the landlord can be negotiated in exchange for its agreement to the surrender, to reflect both its state and condition, the rent that can be achieved on re-letting and to compensate for any rent free that will be negotiated by the new tenant. A surrender will often agree a full release from both past and future obligations of the lease, this should be part of the negotiated heads of terms agreed and expressed in the surrender deed.

The options above can either achieve a full release for a tenant or mitigate its position with residual liabilities. The marketability of the property, the solvency of the tenant and the lease terms are all likely to be relevant considerations. All the options should be considered and good advice taken to establish the best approach.

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