Effects of COVID-19 on the Commercial Real Estate Industry

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 Effects Of COVID-19 On The Commercial Real Estate Industry

Commercial real estate is one of the most affected asset classes since the COVID-19 pandemic broke out in the first quarter of this year.

As many cities and states were put on lockdown, retail stores, offices, restaurants, hotels, and malls, etc. were empty. Hospitality and retail properties were hit almost instantly as voluntary social distancing and lockdowns forced people to stay away.

In stark contrast, activities in warehouses accelerated in response to the rapid and rising demand in e-commerce. Future predictions of how e-commerce companies will replace brick and mortar businesses became a reality overnight. People are shopping online now more than ever and may decide to stick to that even after the pandemic.

However, while the demand for physical commercial properties is declining, demands for warehouses, self-storage facilities, and even distressed properties that could be converted into warehouses are gradually rising.  

The effect of COVID-19 on the commercial real estate industry is not slowing down yet as the virus is still a major health threat. To truly understand the depth of COVID-19’s impact on the commercial real estate industry we decided to reach out to an expert.

So, we talked with Norm Miller, Ernest Hahn Chair, and Professor of Real Estate Finance at University of San Diego to discuss the impacts of COVID-19 on the commercial real estate industry.

Here’s what Dr. Miller has to say:

 

What has been the overall effect of COVID on commercial real estate? Which sub-sectors have been most affected?pexels-chris-panas-2467649

“Obviously in this order, the worst hurt has been hospitality, then retail (not grocers or drugstores but all else), restaurants, event planners, and conference facilities, and all personal service retail (nail, hair, massage, fitness, yoga, etc).”

“All of these have been hurt deeply. Next in line may be the office. But tenants for the most part are paying and simply not there. Multifamily has been collecting rent in the 90% range which is better than expected but has been helped by the stimulus and unemployment benefits and also indirectly by the PPP loan/grants. But as these run out and if no new stimulus occurs, we will see multifamily rent defaults and even front-line worker, lower-tiered housing defaults.”

“Among those that have benefitted from COVID-19 have been industrial, data centers, life-sciences and biotech. In terms of subsectors, within the office sector the co-working platforms have been hit hard and within multifamily, it is the lower priced tiers where the workers are front line in jobs not able to work at home.”

 

Will we still need office space?

“Yes, but probably a little less as we work some at home in hybrid models. Perhaps 10% less, so in cities that are growing this is not an issue, but in weak economies, we will see rents drop. Within the office market, the high rises are currently out of favor and suburban low rise space in more in favor. Large cities like NYC have lost demand while surrounding suburban low rise offices have benefitted from the large city exodus.”

 

Which government measures have most impacted the CRE industry during the pandemic?

pexels-gustavo-fring-4148846“On the plus side: PPP loan/grants have helped along with the stimulus.”

“On the negative side: The lack of federal regulations early on has hurt all of us and delayed our reopening as infection rates continue to grow in more than half the states. The recent CDC ban on evictions through Dec 31, 2020, is unprecedented and a huge leap in mission creep infringing on more nuanced deals negotiated within states.”

“That feels odd given that we were told that states will develop their own policies on COVID-19 until the CDC jumped in. Decisions on closures and protocols, making PPE more widely available could have been implemented early by the Federal government but none of these actions were forthcoming and so now, we all wait for a vaccine to save us from ourselves and those who don’t mind putting others at risk.” 

“Closing the borders might have helped but it needed to be done FAST and broadly applying to everyone for a few weeks while we developed fast tests and tracking protocols. The economic damage would have been deep in any case, but lasted a shorter period of time.”

 

 

What can help the commercial real estate industry recovery from the damage COVID has done?

“Think touchless controls for everything from doors to elevators to bathroom faucets. Automated screening of temperatures and investing in fast tests would be ideal if economically feasible. We will see a number of new amenities and occupant, elevator and visitor protocols to maintain social distancing until we get that vaccine widely administered.

“Opportunities in converting uses from retail to industrial and micro fulfillment centers have already started occurring and will continue.”

 

Impacts of COVID-19 and Force Majeure  

The pandemic has interrupted the implementation of several commercial real estate deals from construction contracts to development deals. Various parties are currently considering the force majeure clauses as protection from expensive breach claims.

Force majeure clauses protect a party from claims if it is unable to work as a result of an unpredictable event when the deal was agreed upon. The clauses precisely mentioned the exact events that could prompt the protection. These include acts of war or terrorism, fire, strikes, epidemics, and natural disasters.

Work delays or failures are typically let off the hook if connected to at least one of the indicated events. The pandemic and government stay-at-home order stopped several construction and development projects. However, even if force majeure is applicable, a party may only be allowed to delay work and not abandon it entirely.

 

Conclusion

The COVID-19 pendulum is still actively swinging. While the world awaits an effective vaccine, it’s hard to tell how soon it will arrive. As such, commercial real estate property owners have to find the most effective methods of mitigating risks while the pandemic continues. 

Commercial real estate property owners can mitigate risks of COVID-19 by performing a sensitivity analysis before making decisions in this new normal, evaluate their commercial real estate asset, consider the highest and best use of the space, and perform in-depth due diligence prior to making decisions.