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The future of leases after Covid-19 – evolve or perish?

This comes as no surprise given that, after staffing costs, the largest overhead for most businesses is real estate. However, in recent years there have been nudges towards greater flexibility and innovation, and the Covid-19 pandemic has thrown the suitability of traditional leases into question.

The uncertainty created by the pandemic means there is considerable appeal for many in finding more flexible workspace solutions, provided through shorter term rolling contracts with smaller initial investments. This allows tenants the opportunity to move, expand and contract according to business needs while maintaining a degree of control over costs.

As a result tenants witnessed the benefits of flexibility, such as the ability to request additional or reduced services (and adjust contributions accordingly) and change opening hours on short notice.

Pandemic clauses as a new uninsured risk are becoming increasingly common.

For retailers there is an increased focus on turnover rent linked to footfall and online turnover as the public has resorted to online shopping. Landlords have been forced to reconsider and adapt break options and alterations, alienation and yielding up provisions to suit changing government guidance and retain tenants.

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Small and medium-sized enterprises and start-ups – which focus on online presence and do not place the same value on physical brand and space – are favouring single-cost solutions which incorporate services such as conference and technology facilities in addition to bare space into a monthly fee, and are happy to take on this often more costly solution in exchange for convenience and flexibility.

Investment in ESG-focused real estate has grown significantly, with tenants becoming increasingly environmentally aware and demanding higher standards in sustainability from landlords.

ESG, which has not traditionally played a prominent role in a lease, is now a significant consideration as landlords and tenants look to demonstrate their environmental credentials and commitment to achieving net zero. This is encouraging tenants to consider how much space they really need, and the viability and benefits of remote working (particularly for office workers) have been clearly demonstrated during the pandemic.

There is increased focus on technology, as employers turn to automation and artificial intelligence to increase efficiency. Technology has become indispensable in the workplace, regardless of the sector or type of company, and tenants expect tech-enabled workspaces.

Through technology, the purpose of the workplace in many sectors has shifted from the provision of adequate space for employees to work comfortably onsite, to a ‘hub’ to facilitate remote working. As the desire and need for tech-enabled workspaces continue to gather momentum, the amount of space required by tenants will inevitably shrink, forcing landlords to repurpose their offerings.

These changes are forcing some landlords to move towards mixed-use properties, which will impact lease structure.

Traditionally, a property was either commercial or residential; however commercial premises are being repurposed to accommodate residential and commercial tenants.

Landlords and tenants with surplus space may look to take advantage of the lean towards flexible working in letting out space on short-term rolling contracts. However, in industries such as financial services, pharma and data security, tenants may prefer to have their own lease or even buy the freehold to a building that particularly suits their operations.

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Among all this change and uncertainty, there will still be a place for the traditional lease.

There is comfort in familiarity for some and a reluctance to move towards flexible and remote working from those who view the changes as simply a blip caused by the pandemic rather than an acceleration of the inevitable. For others, flexibility will come with unfeasible costs and of control, while some simply prefer the work-life separation allowed by traditional ways of working.

There is no doubt however that a one-size-fits-all traditional lease no longer works.

The challenges of the pandemic have brought forward the need and opportunity for radical change which both corporate occupiers and landlords must take advantage of.

The demand for flexibility and balance has never been greater, and an opportunity has emerged to develop and normalise tenancies that are tailored to suit both landlords with their continuing investment and tenants in paying an affordable rent for premises that genuinely work for them.

The opportunity for innovation and the development of truly transparent and collaborative landlord and tenant relationships has never been better and should be seized with both hands.

Laura Darwin is real estate associate and Paul Jayson is real estate partner at DLA Piper

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