During this unprecedented time, we have been contacted by many clients asking questions about how this will affect the commercial real estate market and their strategy for space and lease negotiations. At Flinn Ferguson Cresa we advise commercial occupiers in all phases of workplace strategy, location strategy, design, construction management and many others. Our core competency is transaction management and the majority of our revenue comes following the completion of a transaction. So how are we advising our clients who have a lease expiring in the next 2+ years? We are advising them not to transact for the foreseeable future unless they have a specific need. Some examples of specific needs are:
If your lease is expiring in the next six months, we would advise you to begin contemplating a short term extension with your existing landlord. If you have any of the other specific needs listed above, we suggest you connect with your tenant advisor to better understand your options. Each situation is unique and your tenant advisor can help you understand how the market has reacted to this point and work with you to strategize a path for the future.
If your organization isn’t badly hurt by this pandemic and/or has enough operating capital for the foreseeable future, our suggestion is to wait and see how the market is impacted by this pandemic. There are too many questions that need to be answered before we will understand the impact of this crisis on commercial real estate: When will the shelter in place order be lifted? When will we have a vaccine? Will people be happy and productive working from home, thus impacting future demand for commercial space? Will there be a lot of sublease space coming to market? If the infection rate dips, will COVID-19 come back in the fall? When we do reopen our office, will we have to reorganize our space to accommodate better social distancing?
Given this is a biological pandemic and so different and unique compared to other causes of recessions, historical data may not be relevant. Economists at the Fed’s St. Louis district predict peak unemployment could reach 32.1% compared to 24.9% at the peak of the Great Recession. Speaking of the Great Recession, the below graph shows office vacancy in downtown Seattle between 1/1/2008 and 1/1/2011.
As shown, during the last recession it took ~15 months following the stock market crash and failure of Lehman Brothers, Washington Mutual, GM etc. before vacancy peaked and rental rates hit bottom. We expect this pandemic to have a significant effect on rents and vacancy again, but it is different. How steep the respective curves will be and how low/high they will go is unknown, which is why you should wait if you can.
We have been asked whether or not approaching a landlord to discuss rent relief would be appropriate/worthwhile. Each case is unique with factors such as the landlord profile, debt obligations, and likelihood of tenant default all playing a factor. A tenant requesting rent relief should be prepared to provide historical and projected financial information along with a lot of answers to other questions about how COVID-19 is effecting your business. Many landlords are showing a willingness to provide assistance. A trend we see emerging is for landlords to provide up to three months of rent abatement, which would then be added on to the end of the lease term, or amortized over any 12 month period during the lease term. Another trend we see is Landlord’s allowing a portion of the security deposit being held be applied to all or a portion of upcoming rent due. If you do need rent relief we suggest starting the conversation directly with your Landlord as soon as possible. Establishing non-confrontational and transparent relationships will be key for all of us to get through this.
Below are some links to PDF’s and more information that we hope will be helpful:
The Seattle Mayor did issue an emergency imposing a moratorium on small business and nonprofit tenant evictions for non-payment of rent. This moratorium is in effect until the earlier of (i) 60 days from the imposition of the emergency order, or (ii) the termination of the civil emergency declared in the Mayor’s Proclamation of Civil Emergency from March 3, 2020. This order can be read in full here.
For purposes of the moratorium, “small business” means any business entity that is owned and operated independently from other businesses and has fifty or fewer employees per establishment or premises.
During the moratorium, the property owner cannot enforce a contract provision or statutory remedy that would remove the small business or nonprofit from its premises (including terminating the lease or terminating the tenant’s right to possession). The emergency order further provides that the property owner will “endeavor” to enter into a payment plan or other workout agreement to assist any distressed small business or nonprofit tenants, which may include deferring the payment of rent or discounting the rent. In addition, no small business or nonprofit tenant can be charged late fees, interest or other charges due to late payment of rent during the moratorium.It is unclear if tenants could still be in default during the moratorium.
Business Interruption generally covers loss of revenue (from which a company can pay the rent due) and additional expenses incurred so long as the cause of the loss is otherwise covered by the policy. Unfortunately, if the cause of the interruption is pandemic virus, this is not a widely insured risk. The reason is that commercial property policies typically require “direct physical loss” to the property and proof of causation. In the event of a claim for coronavirus-related business interruption, questions may arise as to whether this “physical loss” requirement has been met. In particular, in circumstances where a business has been closed as part of a mandatory or voluntary closure − but is otherwise still habitable and uncontaminated − it has probably not suffered a direct physical loss since infectious diseases arising from human-to-human transmission generally will not qualify as property damage. In contrast, if a property has become physically contaminated and uninhabitable due to coronavirus, there may be sublimits of coverage that are triggered for cleanup, etc.
Please do not hesitate to contact us should you need anything.
Sincerely the Flinn Ferguson Cresa Team