The legal and market forces impacting commercial real estate
These are not normal times in commercial real estate, here’s how to adapt
These are not normal times in commercial real estate.
I have received many calls from owners and occupants uncertain about how to respond to the new legal and market forces unfolding due to the COVID-19 pandemic. The legal forces include travel restrictions, stay-at-home orders and the federal legislation. Additionally, customary contract remedies provided in most commercial real estate contracts may not be available due to limited court dockets. The impact of market forces on commercial real estate transactions may affect performance due to loss of demand and disruptions in supply chains.
Separately and combined, legal and market factors are impacting everybody. People that are involved in commercial real estate, in any capacity, need to navigate these factors to survive now and take advantage of opportunities in the future.
COVID-19: Legal issues to consider
The business operations of owners and occupants are likely impacted directly or indirectly by legislation and orders passed in response to the novel coronavirus pandemic. Here is an overview of some of the laws passed to address the COVID-19 crisis that impact commercial real estate:
- Everybody in Colorado is subject the March 25 Executive Order to stay at home whenever possible, subject to certain exceptions. While some businesses were defined as critical, and therefore exempt from the public health order, real estate transactions are still closing via electronic signatures, electronic recording and remote notarizing (by special permission).
- Colorado Supreme Court Chief Justice Coats issued an order in response to the virus suspending most civil complaints including commercial real estate remedies such as evictions, foreclosures and other contract claims.
- On the Federal level, the Coronavirus Aid, Relief, and Economic Security Act, commonly known as the CARES Act, was passed to address the sharp drop in economic activity. The hope is that CARES provides some relief to small businesses through SBA loan programs and the self-employed through unemployment benefits. Much of the aid for commercial real estate will be in in the form of liquidity support for tenants. Occupiers of all sizes across the office, retail, industrial and hotel sectors may qualify for such aid. By preserving the supply side of the economy, the hope is that the CARES Act will enable a faster recovery. However, it would be reasonable to expect a lag before certain parts of the stimulus are fully deployed.
COVID-19: Commercial real estate market issues to consider
The commercial real estate market is changing in real time to respond to the COVID-19 crisis. There are also several unusual market conditions impacting business operations in commercial real estate right now:
- Uncertainty. It is hard to plan a response when the extent and duration of the pandemic is unknown. While there are areas that have not been as adversely impacted as other areas and some that will come back sooner than others, the only certainty is that the impact of the virus is still unfolding.
- Disruption of the supply chain. Meeting agreement deadlines may be impossible due to COVID-19. On a larger scale, some countries and ports are closed. On a more local scale, slowdowns may result in fewer people employed to facilitate transactions such as loan processors or appraisers.
- Low interest rates. One positive note, the cost of money is historically low for those in a position to borrow. Low interest rates allow owners to save money by refinancing or by seeking other investment opportunities. In this market, the tenant can borrow money to become an owner. However, it is uncertain how efforts to spur investment and growth will perform when people are subject to stay-at-home orders.
- Fluctuating oil costs. Incidentally, the price of oil recently rebounded some based on a new agreement between Russia and Saudi Arabia to cut production. The low gas typically will assist a fuel rebound, but the COVID-19 crisis is also keeping demand low and many oil and gas businesses based in Colorado need the prices to remain above a certain level to be profitable.
Problem solving through workout agreements
With markets and courts acting in an unprecedented and unpredictable manner, business savvy commercial real estate professionals will look to find common ground to salvage relationships. If you determine that sustaining a relationship by meeting accommodations is better than starting over, there are mutually beneficial terms to adopt. Such terms should be memorialized in a written agreement or amendment. Each agreement is different and should be viewed on a case-by-case basis.
Here are a few terms for resolving common commercial real estate issues right now:
- Deferral not relief. The purpose of an accommodation is to reasonably defer obligations until life returns to pre-virus conditions. It is a “time out,” not a renegotiation of the agreement. While an occupant may have a compelling story, the owner will often have its own debt service and operating costs that do not go away, so a deferral or abeyance is preferred. Deferring rent can be partial or full and may not include the payment of operating expenses or common area costs due to the owner continuing to incur certain costs. Only waive rent in aggressive situations.
- Trust but Verify. The party requesting accommodation should be able to explain the need for the deviation from the contract. This may include a requirement that occupants provide financials to substantiate claims.
- Deferral terms. All agreements should be in writing and provide the length of the deferral, whether it’s an amendment or side agreement. The parties may agree to extend the agreement if circumstances require it. Additionally, agree on how the rent, security and other provisions are to be modified. Owners that agree to grant deferral agreements may take the opportunity to increase security or take back some concessions from the occupant.
Recovery from the current situation will take at least the next three months, and maybe longer. Owners and occupants have always had a mutually beneficial relationship and this interdependence has never been more obvious. For owners, good occupants are tough to replace. For tenants, giving up the perfect spot for their business can be devastating to their bottom-line.
Now is the time to pay attention to how the new laws will impact your business operations and spot opportunities. In this climate, working together is not just altruistic, it is good business. Negotiation can be difficult especially in times of emotional turmoil, but our legal and market forces are not on anyone’s side right now. It is the time to find common ground.
Robert Fischer is a commercial real estate attorney at the Fischer Law Office.