Real Estate Alert
As office-property owners grapple with short-term cashflow issues caused by the coronavirus pandemic, they are looking for strategies that will also preserve the value of their properties for the long term.
In many cases, that means working with a tenant that’s hard-pressed to pay its rent, with the aim of keeping it in its space once the crisis eases. It also means reconsidering how buildings should be configured and operated once stay-at-home orders are lifted and workers return to their desks.
As one West Coast landlord put it, the priorities are “to protect value, keep occupancy and collect as much rent as possible.”
The start of April brought the first round of missed rent payments — although several owners said in interviews that the initial impact was milder than expected, with 85-95% of tenants sending in their checks. “Actually, ‘anxious April’ turned out better than expected,” the West Coast owner said. “However, April doesn’t tell a ton about May.”
The first challenge for owners is deciding which tenants should be granted deferments or other concessions, with an eye toward keeping occupancy levels up. One veteran investor with a $25 billion portfolio said his firm is working with tenants it realizes are under strain, including retailers and smaller businesses. It’s taking a harder line with larger firms that have the wherewithal to pay.
“People playing nice goes a long way,” he said. “If they reach out in advance and say, ‘Look, I’m having cashflow issues’ . . . you can figure something out with them.” But, he added, “a top-100 law firm who doesn’t pay, that is billing their clients — that doesn’t go far.”
Co-working spaces are emerging as a particular trouble spot. By and large, owners said co-working providers are missing rent payments as they, in turn, struggle to collect on their subleases. The largest, WeWork, provides a corporate guarantee on some of its leases, giving landlords some recourse even if the company were to file for bankruptcy. But it holds many of its leases via special-purpose entities, leaving landlords with little chance of recovering rents if WeWork gives up its space at a specific location.
The flow of rents is expected to become a more serious problem as the pandemic and its economic effects drag on. In a report last week, Green Street Advisors, the parent of Real Estate Alert, estimated that U.S. office REITs are likely to collect just 70% of second-quarter rents, with 27% deferred and 3% forgiven.
Some owners are negotiating temporary rent concessions in return for extended lease terms. While that means deferring or even forgiving one or more payments, it also increases a property’s weighted average lease term, helping retain value.
One Manhattan landlord is working with his tenants on a rent-abatement plan to cover a property’s operational costs. The owner is negotiating to defer regular rent payments for tenants and instead charge a prorated share of what it costs to run the building for a month. That payment would be drawn from the tenant’s security deposit. Once the crisis subsides, the tenant would either increase its monthly payments until the deposit is restored, or agree to extend its lease.
Plans like this are dependent on forbearance from lenders, however. Loan documents require lenders to consent to lease modifications, the Manhattan owner said. “That’s going to be another bottleneck in this whole situation,” he added. In the meantime, owners are finding ways to reduce expenses. Where offices are sitting mostly empty because non-essential workers can’t use them, buildings can run on weekend-like schedules, reducing staffing, energy and other daily costs. Many landlords are also hoping for future relief via discounted real estate taxes.
However, owners may face additional operational expenses and capital costs when it comes to reopening their buildings. Craig Deitelzweig, president and chief executive of Marx Realty of New York, said there’s a need to reposition and re-think properties for a “new normal,” with health and wellness features and accommodations for continued social distancing when tenants return. “It is costly, it will eat into net income in the near-term, but it will position us for continued long-term success,” he said.
At the same time, they don’t want to reduce in-place or asking rents, or cut costs by eliminating the amenities that will still be necessary to attract new tenants. “Ultimately people will be going back to work and we are looking at attracting new tenants, so we don’t want to do anything short-sighted,” Deitelzweig said.
Owners also anticipate spending more on cleaning, particularly in common areas, and adding disinfecting stations at elevator bays. “There will be additional cleaning services that tenants can see,” said Brian Rosen, chief investment officer at Accesso Partners. The Hallandale Beach, Fla., firm, whose office portfolio is concentrated largely in the South and Southeast, is adding sanitation stations in common areas with gloves, disinfectant wipes and hand sanitizer, and using new technology to clean ventilation systems and improve air quality.
“If you are a building owner and you want to have tenants that pay rents, you have to implement these measures,” Rosen said. “You want your company or your brand to be known as the owner that’s taking care of these things.”
While some tenants are wondering if they can reduce their office footprints by permanently basing employees at home, others are inquiring about expanding their space as they look to create more physical distance between workers, in keeping with recommendations for social distancing. They will be looking to “de-densify” their offices — adding barriers or even traditional cubicles to replace the “open workspace” concept. And properties may need to stay open longer, as employees are split into shifts to reduce the number of people in the building at one time.
“You are going to see these extra costs with added cleaning and safety,” Deitelzweig said. “But I believe tenants are thinking about their space as a benefit to their culture and brand.” He added that “well-appointed, health- and wellness-focused spaces enable our tenants to attract talent and create a work environment best-suited for a culture of creativity and collaboration.”