Flexible workplaces are disrupting the traditional commercial real estate market worldwide, including Germany. This new asset class has implications from a legal as well as commercial perspective.
Flexible workplace operators are to be found somewhere between the polar opposites of a traditional landlord/tenant office lease relationship. They are part of a new three-way structure that incorporates owner/landlord, operator and workplace user. This structure isn’t governed by a single leasing relationship between landlord and office tenant but instead controlled by an operational leasing relationship between landlord and operator and a service agreement relationship between operator and user.
Moreover, the parties involved have diverse interests compared to a standard office lease. Similar to the hospitality sector, operators demand greater flexibility and more extensive rights to use the spaces from the landlords compared to standard office leases. Within a service agreement, the workplace user is treated more as a “member” than an office tenant, with limited rights to use the space.
Even at first glance, it’s clear these operational lease and service agreements have little in common with a standard office lease relationship. Yet market awareness of these differences and therefore the need for “legal adaptations” remains low. In some cases, operational lease agreements are still treated as standard office leases, while service agreement are being dealt with in rudimentary terms that do not take into account the peculiarities of flexible workplaces with a strong office use element. Consequently, an independent contract practice is developing for this emerging asset class.
Operational lease agreements
The flexible workplace business takes in a wider range of ancillary services offered by the operator to the user, which usually goes hand-in-hand with intense integration of technology and communications. Service agreements grant the user short-term usage of space and the ability to adapt to changing demands in size and scope of spaces used (i.e. increasing the office space granted, or using additional conference space). Operators therefore require the ability to quickly adapt to the changing demands of users to optimize their workplaces.
This means operational lease agreements need to include a certain degree of flexibility and broader rights to use the space compared to standard office leases. In particular, this has a direct impact on the commercials in addition to the drafting of the lease purpose, the workplace operator’s rights to alterations of the rented space, and the limitation of landlord’s rights with regards to the rented space.
“Flexible workplaces lie somewhere between the polar opposites of a traditional landlord/ tenant office lease relationship: part of a new three-way structure that incorporates owner/landlord, operator and workplace user.”
Since renovation measures and build out costs are generally higher than in standard office leases, from the operator’s perspective there is a demand for higher upfront capital from the landlord, similar to the hotel operations business. However, cost sharing e.g. furniture, fixtures and equipment (FF&E) contingencies and reserves along with income participation elements are still the exception in contract practice.
Capital expenditure by the landlord is in most cases compensated by a higher rent and longer lease terms. Similarly, instead of profit participation mechanisms, operational lease agreements in Germany generally provide for a fixed rent with rent increases by way of indexation. Overall, the commercial elements in operational lease agreements still lean towards the traditional office lease model rather than towards hotel leases or hotel management agreements. Nonetheless, an increase in cost and profit-sharing models in the flexible workplace sector can already be seen in other jurisdictions and are expected to become a feature of the German market.
A flexible workplace operator doesn’t use the rented space solely for office purposes. Rather, it’s the combination of granting office space plus a variety of additional services to users beyond the traditional ancillary services in an office lease (e.g. furniture, printing, cleaning). Such services might change in scope and variety, which requires drafting an elaborate and flexible lease purpose definition.
Likewise, the landlord has an interest that the operator will run its business within the scope of the existing building permits and in line with applicable laws and regulations. The combination of office and additional services, with increased occupancy by users compared to a “standard” office tenant, requires thorough due diligence if existing building permits allow flexible workplace operations, particularly regarding permitted use under the permit, applicable workplace ordinances, assembly regulations, fire protection, restaurant codes and so on.
Since it is generally the landlord’s responsibility that the rented space can be used for the defined lease purpose in the lease, operational lease agreements usually provide for a detailed risk allocation regarding required permits and adherence to laws and regulations.
Integrating technology and communications systems together with demands for flexible layouts (e.g. open space with possible future partitioning) require broad alteration rights by the operator for the initial fit-out and future adaptions to meet changing user demands while continuing to provide unrestricted access to the building’s central facilities.
Compared to a standard office lease, in which a landlord remains in control of the office tenant fit-out, operational lease agreements provide greater autonomy for the operator. The general layout and redesign of technical facilities are a key point within lease negotiations, since the landlord has an interest to secure third party usage of the space after the end of the lease term. This is why operational lease agreements deal with the technical particularities of the operator’s required alterations in greater detail.
“The rise of flexible workplaces as an asset class and the contractual issues they create require a new legal regime and the development of focused standalone contracts.”
Limitation of landlord’s rights
In a standard office lease in Germany, the landlord has a set of standard access and alteration rights with regard to the rented space. Access generally needs to be granted after notice and the landlord is entitled to carry out all necessary maintenance and modernization works in the space and building. However, compared to a standard office tenant, disruption to the workspace resulting from such works would have a distinct impact on the operator and users. The free enjoyment of the rented space without adverse impairments by the landlord is an important requirement for the flexible workplace business model. For example, renovation works on a building façade may be more acceptable for a standard office tenant than for an operator, who might lose potential users and income as a consequence. Finding a balance between the required rights of the landlord and the interests of the operator for free enjoyment of the rented space is a key element in negotiations for an operational lease agreement.
The type of service agreement between operator and the user can range from detailed subleases to mere membership agreements based on a standardized form, with general terms and conditions for standard small and mid-sized users.
This is generally dependent on the scope of the user’s rights to use the space (e.g. exclusive use of offices rather than hot desks), the proportion of rented space within the flexible workplace center, the duration of the fixed lease term, and the degree of additional services consumed by the user. However, a membership form with general terms and conditions is currently market practice.
While such membership agreements are generally classified as service agreements within the terms and conditions, this is not 100% correct, since the relationship between operator and user entails a lease and a service element. Due to strict laws in Germany, the reasonable drafting of such terms and conditions – taking into account the elements of a lease and a service agreement – is vitally important so the agreement
cannot be terminated despite the conclusion of a fixed lease term due to, for example, changes in the services offered (e.g. right to use common spaces such as cafeteria).
In such cases, the risk would be to trigger an extraordinary termination right in favor of the user even though a fixed lease term has been agreed within the lease element of the service agreement.
In conclusion, it’s clear the rise of flexible workplaces as an asset class and the contractual issues they create, particularly in the differences between standard office leases and the newly-required operational lease and service agreements, require a new legal regime and the development of focused standalone contracts.