The commercial real estate sector had been saying for months just about the only thing that could derail the strong market fundamentals was a Black Swan event. COVID-19 could very well turn out to be that market-reversing occurrence.
A recent poll of Kidder Mathews leaders across the West Coast has helped to identify some of the critical issues currently facing the commercial real estate industry. That practical and proactive advice from the front lines is shared here to help CRE investors, owners, and operators find solutions to survive in today’s environment.
Topping the list of Kidder Mathews counsel for clients is to keep everything in perspective, rather than making ‘knee-jerk’ reactions. A common theme heard across the input received was that companies who are patient, remain clear-headed, and arm themselves with relevant and up-to-date information allows them to make the most well-informed and precise decisions. By fully assessing and understanding the situation now could also lead to better opportunities down the road.
“Some of the best advice I have ever received is: “When confronted with a difficult situation that you need to deal with and you think you need to react right away, don’t. Take some time before you react or respond,” said Brian Clapp, a Kidder Mathews office broker in Seattle. “It is amazing how you come up with creative ideas to address the issue by giving yourself a bit of time to digest and then to formulate a thoughtful solution or response.”
The reality is that the commercial real estate markets were strong leading into the pandemic. Still, there’s reason to believe the resilient segments will adjust in a post-COVID-19 era. New demand may emerge in unexpected areas, which will be aided, as the year progresses, by the actions of the Federal Reserve to drop interest rates to zero as well as the multiple stimulus bills enacted by the government.
Divest or Hold?
“While the COVID-19 crisis has put everything in disarray, this is still a time where the best real estate with the least exposure to this pandemic could trade for at or near peak cycle pricing,” said David Hill, an office and industrial investment broker Kidder Mathews in Portland. “Debt is still relatively cheap and available for the best properties, and there are plenty of prospective buyers with liquidity and a desire to place money in the highest quality assets. Not many are likely sellers of such assets at this time, but if liquidity is a priority, selling a quality asset might be the most effective way to achieve it.”
Kevin Sheehan, an office broker in Kidder Mathews’ Roseville office, says, “If you are a seller, and you do not need to sell, be patient if you want to get your price or the highest value that a buyer will pay. Many buyers look at these “event periods” as a time when they can renegotiate or negotiate a discounted price to entice a seller that needs to sell. If you don’t need to sell, then allow more time for due diligence or closing to allow the panic to subside and give the buyer time to restore confidence in the asset, market, and the world.” He notes now might be a time to “sell properties to generate cash to assist with other problem assets and to take advantage of opportunities that come in a down market.”
Kidder Mathews office broker in Phoenix, Michelle Gardner, adds, for some owners, it might make sense to dispose of assets quickly, “To mitigate risk, I encourage owners to make moves immediately to sell, before we feel the impact. That includes 1031 buyers that need to act or owner/users who can take advantage of the new SBA relief advantages.
Risk Mitigation
The strategies that seem best suited to navigate a market that is volatile and uncertain start with a focus on risk mitigation before turning an eye to long-term planning. There are, however, some simple and proactive steps both owners and tenants can take to manage the COVID-19 pandemic.
“Right now, it’s all about mitigating risk,” says Christopher Steck, a Kidder Mathews office and industrial broker in Los Angeles. “We still don’t know what the future holds for values or what the lasting impact of this pandemic will be on the market and the economy. Landlords need to make any deal they have available to them on the table to increase occupancy now in preparation for a potential rise in vacancies in the future.”
There are some practical ways landlords can work through the current situation too. Jeff Chaney, an office broker in Kidder Mathews Bellevue office, offered the following advice for landlords and their brokers. “Keep spaces occupied in the near term and be proactive with vacancies and pending deals in order to get leases executed,” he says.
Chuck Wells, a Kidder Mathews retail broker in Phoenix, offered some advice when the future isn’t clear. “What we do know is that everyone needs to take a deep breath and invest a little time in understanding what is in your lease document.” That means both landlords and tenants should carefully look at and understand “what the language states, what constitutes a default, and why we advise not using it as a negotiating tactic,” he says.
Initially, over the next 60 to 120 days, owners and landlords need to get a sense of rent collection challenges as well as any cash flow or liquidity issues that must be addressed with lenders or mortgage holders. Next, over the subsequent 5 to 12 months, Hill says, a second “stage of planning will continue to have a strong focus on liquidity needs, which could lead to planning for potential downsizing, tapping into real estate equity (sales, sale-leasebacks, debt), or restructuring of leases.” He notes, these actions will set up outcomes months down the line.
Strategic Next Steps
Eventually, owners and tenants alike will start to see what that future holds, and their approaches will be shaped by the type of properties they hold or the business they are in. Each sector is different and has its own unique challenges and opportunities.
Dan Mathews, an office and industrial broker in Kidder Mathews Seattle office, notes a paradigm shift probably occurred several weeks ago as remote work strategies began to be deployed, which are reshaping worker habits. “By the time people are cleared to come back, those that can work from home and found ways to communicate effectively will have adapted and [remote work] will become a factor that plays into the surviving companies overall operating expenses.” This shift could result in reduced office space needs, a situation that owners would be wise to start planning for now.
During this period of uncertainty, mistakes could be costly if landlords and tenants aren’t careful. Steck notes, “On the landlord side, we find our clients that prioritize their occupancy and credit vs. achieving maximum rents are best suited to weather this, or any future storm.” He says, “exercising caution” and following diligent underwriting practices now during a volatile time rather than “hastily jumping into a deal” would be wise.
Rachel Corp, a retail broker in Kidder Mathews Tacoma office, agrees. “The biggest mistake is to react to a daily news cycle,” she says, “It seems to me there will be some great opportunities for stronger companies to acquire assets at a discounted price from companies that won’t survive.”
A smart strategy might also include some simple, client service approaches. Mike Ciosek, SIOR, a Kidder Mathews industrial broker in Phoenix, says, “In a time like this, it’s best to get back to the basics of what got you in the door to begin with. It makes you feel that what you do on a daily basis is of value, and also leaves the people that you touch with something they can use to their benefit. Make sure this comes from a place of ‘How can I be of service?’; You may be surprised by how your business thrives.”
Darrell Levonian, a veteran Kidder Mathews broker in Los Angeles, believes the opportunities that will come from this extraordinary time are dependent upon the ability to remain calm and persist through challenges. “There is likely no single strategy that will apply to every property or situation,” he says. “Depending on the real estate asset type, its location, and the occupier, there will be a variety of outcomes.”
Yet, he is confident a clear path will emerge by choosing to be successful rather than wishing for it – embracing the disruption and chaos. “Today, the opportunities for profit and success in the market all remain. We are just in a severely different situation than ever before,” says Levonian. “We must not let the negative psychological impact evolve into a story that will keep us from success. We must invest our intellect into this time and Stay Calm and Carry On!,” Levonian concludes.