The coronavirus pandemic could alter the way office space is used in the future, but in the present, it’s putting a lot of strain on building owners and their tenants, according to two commercial real estate experts who hosted a webinar for NAIOP members this week.
“Unfortunately, transactions are pretty much on pause,” said Gregory May, executive vice president and West Region market leader for Newmark Knight Frank. “There aren’t a lot of new deals going on. The deals that are in process are probably going to be renegotiated with different terms. I’ve been told by some landlords that 10% to 20% of the deals are basically dead. Maybe 10% of the deals are moving forward, and 70% are on hold.”
Despite that, Pamela Westhoff, a partner in the real estate, land use and environmental practice group with the Sheppard Mullin law firm’s Los Angeles office, said she’s heard that most tenants are paying their rent – at least this month.
“My clients are reporting that about 80% of their tenants have paid their rent for April,” she said. “But I think everybody was kind of waiting for the next month to see what happens, and a lot of people think that is going to be different.”
Westhoff said many tenants are examining their leases to see if there are provisions that might allow them to stop paying rent, especially in situations where they are locked out of their spaces by government order. She noted that the much-discussed force majeure clause might not be a savior.
“You probably saw a lot of content about the force majeure clause, and a lot of landlords thought, unfortunately, that business-interruption insurance would allow the tenant to get some relief from their insurance company,” she said. “As of now, I have not seen a force majeure in a lease that has given anyone a slam-dunk right to not pay their rent. Nor have I seen a successful frustration of purpose clause, which a lot of people look to as well.”
“Unfortunately so far, even when we drafted our leases, a lot of landlords believed ‘OK, I’ll get this business-interruption coverage and that will cover it,’” Westhoff said. “But because there’s a pandemic, a lot of people are finding that there’s a pandemic exclusion, which has made them unable to collect those insurance proceeds. So everyone’s stuck.”
On the positive side, Westhoff says she’s witnessed more cooperation and communication between landlords and tenants in the past month than she’s ever seen.
“I’ve been through four cycles, and I feel like that’s something that’s different in this environment,” she said. “People are trying to treat one another fairly.”
Westhoff also urged tenants and landlords to communicate.
“As a tenant, don’t just not pay rent and not say a thing,” she said. “As a landlord, if someone isn’t paying rent, give them a call and see what they’re doing. I think a lot of people have done that, and there’s better communication going on. It’s nobody’s fault, so to speak. In the office market, everyone feels stuck, so everyone’s forced to try to work together. And I hope that will continue.”
May and Westhoff also answered questions from webinar attendees.
Q: How are conditions in the capital markets?
May: Capital markets have really slowed down significantly. The debt markets have really stopped in many respects. There are very few insurance companies and banks lending. The capital market business is really on a pause right now. I’m hopeful that when we see light at the end of the tunnel and the lending business loosens up, we can get back to some normalcy.
Q: What is going on with spec construction during this time?
May: My understanding is that it’s continuing in most states, but there are interruptions. If you lose a subcontractor because he’s fearful or has health issues, that stops the project. Things are continuing, but not at the same pace.
Q: What are landlords doing when a tenant has lost all its business and wants to terminate a lease that hasn’t commenced yet?
Westhoff: There are a lot of variables. This is where I like to believe there is going to be fairness. So if the landlord has already spent money for tenant improvements or anything like that, I would hope that the tenant would sit down with the landlord and look at the actual cost. It depends on the terms of the lease, but there should be a provision that says the tenant has to proceed with their planning and the lease would start. Usually the tenant’s not going to walk away for free. It’ll depend on the jurisdiction, but for the most part, I think most state laws will require the landlord to not sue for the rest of the rent they would have gotten.
And now the question is going to be, ‘OK, but maybe it’ll take me 6-8 months to get another tenant, and maybe it’s going to be a lower rate.’ So the next question will be, ‘Who’s your tenant? Do you have an entity that has the assets?’ Say you’ve got a tenant who has lost his business and may be on the verge of bankruptcy. You can be angry and try to collect, but you probably won’t have many assets to go after.
May: There have definitely been some deals in process that have been renegotiated in the last three weeks. A lot of tenants are going to choose to go short – one-year leases. You don’t have a lot of certainty right now, but over time, it’ll get clearer. Right now it’s difficult to sign a long-term lease.
How big of a correction to rents will we see once the economy bounces back?
May: I was around in 2008 and 1992-1993. I’ve seen a few of these. I’m optimistic – most brokers are by nature. I do think there will be more vacancies than we’ve seen in a long time. There’s going to be a correction. How much, I just don’t know at this time. This really is a black swan event. We’re not overbuilt. We have some pretty good fundamentals going on in the marketplace. We’ve just got to get back to work and hope that we can continue keeping our rents close to where they are, but there’s definitely going to be a hit.
Westhoff: There’s been some predictions for Q3 that haven’t been so bad. Everyone will be anxious to get back to work and buy things and go to restaurants.
Q: What are you seeing in terms of CMBS loans and how they’re addressing forbearance?
Westhoff: As you’re dealing with tenants backing out and tenants not paying rents, the big elephant in the room is obviously the lender that still wants their payment. One thing I’ve heard is to be very careful how you approach it. I’ve heard that people are listening if you can find the right person to talk to. I’ve heard that some have been willing to go to interest-only loans, and they’re in discussions about how to restructure the loan going forward.
I’ve been telling my landlord clients that nothing’s binding until the lender approves it. It involves going to the lender and saying ‘this is what I’ve got to do, you’ve got to help me on the other end.’ There’s been talk about paying your April payment so you can get into a discussion about May.
Read the first part of this webinar recap: Experts: COVID-19 Will Change the Nature of Work, But the Office Will Survive
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