April 27, 2020

Commercial Real Estate Feels the Impact of Pandemic

Point by Point

This episode of Point By Point was produced prior to the combination of Waller and Holland & Knight.

As our economy continues to feel the impact of COVID-19, the commercial real estate industry is taking a direct hit. In the near-term, industry leaders are concerned with preserving value and liquidity, keeping tenants and visitors safe, and complying with governmental requirements. Bo Campbell discusses the potential short and long-term impact of the pandemic on the real estate industry; key questions industry players should be asking; and practical next steps. 


Morgan Ribeiro, Host: Today on PointByPoint, I'm joined by Bo Campbell, who is the co-leader of Waller's real estate industry team. Bo works with real estate developers on transactions and investments, and today I'm joined by him to talk about the economic uncertainty and options that are available to those in the real estate industry.

Bo: Thank you Morgan, and I'm happy to be here this afternoon. I think that the best description of the market today is that it is in limbo. It has stuck somewhere between optimistic and lost, quite frankly. We've had such a strong market for the last several years, and we've been hit with this unusual event for which there really is no precedent. And so the real estate market just doesn't have a lot of visibility on how long this may last and what the impact will be sort of coming out of this. And so, it's in limbo is what I think is the best way to describe it.

Morgan: And are there certain concerns from your clients right now that you're hearing? When your phone's ringing every afternoon are there some common questions or concerns that you're getting across the board?

Bo: I think that clients are concerned about the health of the lending and financial markets and the impact it may have on their projects. And for most real estate projects, which are driven by landlord tenant relationships, the health of the landlord and the tenants, particularly the tenants. You know, they pay the rent and offices and warehouses and shopping centers and, you know, making sure they stay healthy and alive and can continue to function on the other side of this is of critical importance to everybody because they really are reflective of the entire consumer economy which drives everything.

Morgan: Are there certain areas within the real estate industry or certain types of developers--multi-family retail, hospitality, for instance--that are feeling more pressure than others?

Bo: Certainly the hospitality industry has really been hit hard, and I think anybody who watches the news has seen that restaurants are closed other than for take-out, for the most part. Hotels are either closed or effectively closed because no one's traveling or staying any. And so those are particularly impacted when you can't gather, can't go restaurants together, you can't go to hotels and things. So those are really struggling.

Retail is similarly injured because we have these safer-at-home ordinances and restrictions that state and local governments have issued, which effectively shut down many, many retail businesses that are deemed non-essential. So if you have a retail shopping center and all the businesses are closed, that's very impactful. Those are where the real guts of it, in terms of the impact of this virus and this whole safer-at-home process.

Multi-families so far seems to have weathered the storm to some extent. Reports of April rent collections were pretty good, much better than I think people expected. Obviously, there's been massive amounts of new unemployment the last two or three weeks. And so how that might impact May and June and July rents is yet to be seen, and certainly a very close eye will be kept on that.

Morgan: So another area of the real estate market is office space. Thousands of companies have quickly reorganized to enable their employees to work from home for the foreseeable future. And the success of these efforts really raises the question, what if these companies now decide that they don't need as much office space to lease as they once previously believed, and what could that mean for commercial real estate market in the long run?

Bo: Well, that's an astute observation. Certainly, working remotely is taking on a whole new meaning in our economy. It's gone from generally isolated, maybe siloed areas of firms that are able to work on their own and don't need to be in a collective atmosphere, to entire companies having to work remotely and having to figure out how to do that and try to maintain that collegiality and the interpersonal dynamics that are so important to many businesses. So I think that everyone will be looking at their need for office space going forward. And everyone will look at the need of how their office space ought to be configured going forward and what kinds of parts of their work can be done remotely, what's been effective. They'll look at what parts of their businesses performed really well working remotely. What parts struggle. And so if I had to guess, I would suspect that you'll see a lot of analysis of office space needs. I do think over time, in the longer term you'll still see a significant need for good office space because so much of the world works on a collaborative basis and we are humans and we are social animals. So we do like working together a lot. So over time I think that will level out.

Morgan: So switching gears here, you know, I think there's a lot out there right now in terms of the options that are available, the funding that's available. But I've noticed a lot of conversation around this topic of force majeure. What options could that provide for landlords and tenants? Could you describe exactly what that is?

Bo: Sure. Force majeure is a fairly arcane legal concept that no one thought a whole lot about, or not very often until this, other than maybe a hurricane or a tornado. And so almost every contract or lease or loan agreement will have some language that describes what force majeure, which is typically an act of God, or an act for which a party doesn't have any control, what is defined as force majeure and what the consequences or benefits of that force majeure action might be. And every contract is different, and so you know, we have to look at each one separately. It's got to stand on its own two feet. But it would not be unusual for contracts to give both parties some right to extend or forestall performance of certain obligations while a force majeure condition exists. Typically, it doesn't include payment obligations. It might, but it typically doesn't. And so there's a lot of wringing of hands and gnashing of teeth around how force majeure contract provisions may be interpreted in light of obligations to pay rent or make loan payments, or things like that.

Morgan: So, not exactly a black and white concept. Seems like there's a lot of gray area there, but definitely something worth exploring.

Bo: Needs to be explored, and it should be explored. Everyone should be pulling their contracts out and reading them very carefully to see what options and benefits it might give.

Morgan: Okay, so in addition to that, I think most of the coverage right now has been around the stimulus funds approved by Congress. So there's SBA loans, there's PPP loans, and then heard about Main Street lending more recently. It sounds like, you know, last week, the PPP funds in particular ran out but that Congress is now very close to approving a substantial amount of additional funds. So can you speak more specifically to some of those options or other options that are available to those in the real estate industry?

Bo: Well, certainly a great deal has been written about paycheck protection program loans, PPP loans. Millions of businesses apply for and receive those. The monies did run out last week. They have been or about to be renewed and expanded, so hopefully they'll be a lot more money available for other deserving small businesses. Those loans are critically important to a lot of small businesses. There are limits on the use of those monies. 75% of the money has to be used for payroll purposes. But for businesses that are making payroll anyway, or lots of most of their payroll anyway, it effectively frees up money that they would have had to spend on payroll to do other things to keep your business going, pay rent, pay, utilities, pay taxes, pay vendors, those kinds of things. So that's been a really important program, and we'll see a lot more of that as it's been expanded. I think we'll see that be much more effective with new money that's going into it.

The Main Street lending program is also, I think, there's a lot of hope and optimism around its availability and the benefits it might provide to larger businesses. It's supposed to be for businesses between 500 and 10,000 employees, and it is not fully in place right now. The Federal Reserve and the Treasury Department have just finished taking comments and they're issuing guidance. We hope any day now to get lenders and borrowers from direction on what this will look like and how the loans could be obtained. Unlike the PPP loans, they would not be forgiven. PPP loans are effectively free money if they're used correctly. The Main Street lending program will require an interest rate, although modest, and repayment over a period of time, although an extended period of time and there unsecured, which is very helpful to so there's a lot of hope that program will come out and be very effective because millions of businesses could not qualify for the PPP loans.

Morgan: So if I’m a real estate developer, what do I need to be paying attention to right now, what advice do you have for me? I know your phone’s been ringing off the hook. So you know what recommendations are you providing to your clients right now if they're not really sure where to go and what to look at?

Bo: Most real estate developments would probably fall into two categories. If I was in the first category, which is my project was in process, then my advice would be keep your foot on the gas to get the building of the project completed. Contractors in almost all states or most states and certainly Middle Tennessee are considered essential services, so that they can work. You can continue building your project. You can actually maybe do it more efficiently. There's less traffic for your workers to contend with. There's less impacts on trying to move heavy equipment on and off sites because there's not traffic there, things that actually can accelerate and make it easier and more efficient to get work done on large projects. I would keep my foot on the gas. I would be watching carefully the financial markets, and I would be in very close touch with both my lender and my perspective tenants in my project to make sure everybody's still on board and you're being sensitive to their needs and you're being in communication with them. Communication’s really critical.

If I was in a pre-development stage and I had a project that for which I maybe had not yet closed my financing or closed on the land, I would probably step back, find a way to buy some time to see how this may play out over the next 30 or 60 or 90 days. Lenders are gonna be antsy to close right now anyway. Tenants are gonna be antsy to sign a new lease right now anyway. And so, finding a way to buy yourself more time either by extending your contracts, getting your contractors prices held on your construction projects in things that will give you enough time to have the right visibility into the market to know when and how to kick off the project is what I would be doing at this point.

Morgan: So you mentioned communication just a minute ago and it occurred to me to ask the question about if I'm a landlord, I have a project that's already been completed, I have tenants, should I be proactively reaching out to my tenants to ask, you know, how is their business doing? And do you need options beyond what our current lease terms state?

Bo: Well, that's a great question, too, and I think it really points to one of the most critical concepts through this entire stretch of time, and that is communication. Not just landlords to tenants, but tenants to landlords, landlords to lenders, lenders back to their borrowers. Yes, I think landlords need to be in touch with their tenants. Their tenants are the lifeblood of their projects, and you want to know how their health is. Most good landlords stay in good touch with their tenants, and so they need to just reach out and do that again.

On the other hand, tenants need to do the same thing. Tenants don't need to just arbitrarily sort of take some rash action and stop paying or close up without talking to the landlord. They need to reach after the landlord and tell them. I promise, all the landlords know that it's a problem and they'll be open to listening.

And then borrowers need to talk to their lenders. The lenders are aware of the problems as well, and most of them are being very receptive to short-term adjustments in terms of trying to find ways to get people through what everyone hopes to be a relatively short-term problem. But communication is very critical, and it's really important that all parties stay in good communication through all this.

Morgan: You know, I think in any situation like this there are those that are sitting back on the sidelines, sort of watching it play out, and see opportunity that could come out of this. Do you have any recommendations for real estate investors who may be looking at potential down the line to invest in distressed real estate properties?

Bo: Well, there's certainly seems that there will be opportunities to find distressed properties. I think of it like buying stocks that have dropped significantly. You still have to pay close attention to the fundamentals. And just because a company stock dropped a long way, if the company's not a very good company, you still may not want to buy it. Well real estate is the same way, and the one fundamental that has been universal forever is location. Location’s critical for real estate, and when you see the prices start to soften, if you do, which it could be, and still you've got to look at the fundamentals, which is primarily location. And so there may have been some marginal locations where the prices had run up because the market had been so strong. If those prices drop, you've got to be sensitive to that fundamental of location. And so, my biggest counsel there to clients who talk about it, and most clients are pretty astute about it, is the location still really matters, and you've got to focus on that.

Morgan: Yeah, leading up to all this I’d say, for the past couple years, there's been a lot of talk around opportunity zones and what clients should consider when looking at those. How has the COVID-19 pandemic impacted opportunity zones and the financial markets?

Bo: Opportunity zones are interesting. I think as most know, it's an opportunity to reinvest capital gains into businesses or properties within opportunity zones and effectively shelter all your tax gain over time from income taxes. It's a two-edged sword here. One is, with the stock market and the real estate markets being so soft, the ability to generate gains to then go invest in opportunity zones,  is maybe impaired because all that gain in the stock or on a piece of property may not be there or maybe the property’s not liquid, and you can't get the gain out.

On the other hand, tying back into the earlier question about distressed real estate, it may very well be that in opportunity zones, most of which are in areas that were designated as opportunity zones because they needed the boost to be effectively developed, it may be that those are, you see the prices soften there a lot more, and so the ability to then invest gain there and at a value and protect all your future gain could be very attractive. So it's early to tell, right now. It's possible that it could be a real opportunity.

Morgan: Switching gears here a little bit. I'm curious, you've been in this industry for several decades now, there's gotta be some similarities and potentially some differences to other challenges in the market in the past. There's been highs, there's been lows. How does this compare to 2007 or maybe some other similar examples?

Bo: It's interesting to watch the real estate business. Early in my career, in the mid to late eighties, there was a massive collapse of the real estate financial markets. The entire savings and loan business collapsed. The real estate side of the banking business basically collapsed, jeopardized many banks in the country. Those were fundamental economic problems in the structure of the economy and the structure of the financial markets, and it took many years to get over those.

Then you saw 9/11 and that was one event that was short-term. had longer-term ramifications. But it was short-term. It rattled the markets. We fairly quickly got through it and got back to normal fairly quickly.

‘07 and ’08 was a recession that was much different. It went to the very fundamentals of the real estate market and the financial markets, and were very dire consequences on the long-term health of the markets, and it took much longer for the markets to recover from that.

This looks to most of us more like 9/11 than it does ‘07 and ‘08. It is an event. Hopefully, it's an event. Hopefully it has a limited duration. And while it may leave bruises and scars, we went into it with a very healthy economy with very strong market fundamentals, and there's nothing to suggest that we won't come out of it with those intact once we again tend to our bruises and scars from this terrible pandemic event.

Morgan: I think it's good to have that perspective as we look at what our options might be, and I would love for you to get out your crystal ball and tell us what you think the next few months, either in the near term or long term, might look like for those in the real estate industry.

Bo: Well, boy, I wish I had a great crystal ball, but I think that what I hope and I think most folks in the business think is, you know by late second quarter, early third quarter, there'll be more stability in the market, and by stability I really mean more visibility into what the market, what the impact of this pandemic has had on the market. Who has been hurt, what properties were most damaged, what the lending market is gonna look like, how the federal intervention has played out and how what it has done to help stabilize things. And I think at that point, the market gets its legs back under it and then has better prospect a better visibility and what its prospects are and what things will look like in the medium and longer term. And so, you know, one would certainly hope that by mid-summer we'll know a whole lot more and feel a lot better about where we are so that we can make good long-term investment and development decisions and try to get this train back on the track that it was on for several years.

Morgan: Bo that was incredibly helpful. There's so much information swirling around out there. I know there's a lot of questions to still be heard on the real estate side, but appreciate your time this afternoon and look forward to further discussions on this topic.

Bo: Thank you, Morgan.

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