Five Commercial Real Estate Trends To Watch In The Wake Of Covid-19 – Real Estate and Construction
It has been a 20-month whirlwind for commercial real estate (CRE), which, like so many other areas, has been particularly hard hit by COVID-19. According to a recent report, the pandemic caused the worst recession the office sector has ever faced – causing property owners to find new ways to attract tenants, tackle changing rental structures, and a host of other COVID-related issues. Additionally, COVID-19 has led many observers to question and question the fundamental way we work, and most importantly, where we work
On the other hand, despite the persistence of the pandemic, other areas in CRE have proven remarkably resilient. As the economy continues to recover, PwC data shows that huge investments are “flowing into real estate”.
In any case, the ups and downs of CRE will continue through 2022, bringing with it new challenges, opportunities and uncertainties. With that in mind, here are five CRE trends to consider, along with key guidelines to help owners prepare for this evolving market.
1) The emergence of new rental structures: short-term, flexible and different
With the move to remote or hybrid working, the drop in some CRE scores, and the ongoing uncertainty due to the resilience of COVID-19, it’s no surprise that many tenants want flexible, short-term rental structures. This is especially true for smaller deals and ongoing leases, many of which have been extended at short notice.
Against this background, the new rental contracts were not as affected as many might think: More than 75 percent of the new rental contracts signed in the first half of 2021 had terms of more than four years and 25 percent had terms of more than 10 years. Percentages consistent with pre-pandemic levels. The full effect of the COVID-related changes in the use of work and space may only come into play when larger, existing leases are due to be extended or until it is clear to what extent remote work will result in a permanent change in the use of office space and, ultimately, a requirement .
As for other pandemic rental terms, the past 20 months have shown that the definitions of force majeure need to be changed to accommodate circumstances like COVID-19. Otherwise, however, not much has changed in these rental conditions. Tenants have generally failed to pass force majeure risks on to landlords, although tenants (mostly retail tenants) have in some cases been able to negotiate safeguards if they are unable to carry out their business in the future due to pandemic-like events.
The central theses:
- Lenders, developers, contractors, landlords, tenants and borrowers must assess the impact of any relevant “Force Majeure” or “unavoidable delay” provision or clause on construction contracts, leases and loan documents that may extend the deadlines for performance of agreements. This is especially important now as rampant supply chain bottlenecks continue to cause construction delays.
2) The pressure is mounting to design a new type of office
We all know the ongoing (and unresolved) discussions about the future of office space and new work models. While some companies have chosen to mandate a return to the office, many others have accepted the fact that flexibility will continue to be a major hiring and retention issue even after COVID-19 passes. Many of these companies are actively looking for ways to make the office attractive to their employees, either through the physical characteristics of the space, improved amenities, or proactive programming to ensure that time in the office is well used and devoted to the things that just get through achieve personal interaction.
Landlords must work with tenants to adapt to these terms. For those with empty office space, solutions to increase demand could include improved furnishings, more outdoor space (e.g. terraces, courtyards) and less compression. Some of these facilities (like gyms) can be provided by the landlords themselves, while others (like retail space) can be addressed by promoting leases with users through third parties who complement and meet those needs. At the same time, landlords have to introduce new security protocols such as better air filtration and additional cleaning, which increase cost pressures.
While many believe the rise in coworking and flexible office space might serve some of that need for flexibility – JLL predicts that 30 percent of office space will be flexible in some form by 2030 – it remains to be seen whether this market will actually pick up steam, like many expect.
The central theses:
- Building equipment is not enough – landlords need to work with existing and potential tenants to redesign the office to uncover the purpose it is serving at the moment (z wants it to be. A challenge for landlords is getting tenant feedback in the Past has shown that tenants and their employees do not really take advantage of many of the amenities they build, and landlords need to be creative and forward-thinking in this endeavor.
- Landlords looking to build new amenities may need to consider alternative arrangements with tenants to keep their businesses afloat in the face of pandemic bottlenecks (while developing an exit strategy if commitments are not met). Such arrangements can include short term leases, percentage rental (i.e. the tenant pays a certain portion of the sales proceeds instead of a fixed monthly rent), and management contracts (i.e. when the landlord takes over as owner of the business). .
- Some landlords may try to fill vacancies by licensing vacant space as fully furnished, flexible office space until they find a long-term tenant. Some landlords have teamed up with experienced management companies or flexible space operators. Such prefabricated, flexible office space allows landlords to invest less capital in real estate and give employees more choices about how and where they work.
- In the coming months there will be uncertainties about what happens when leases are extended and what changes may result in financing underwriting (e.g. termination or contract law). Landlords should be prepared to deal with these potential changes as they renew.
3) Climate risk and CO2 emissions laws will continue to affect leasing, especially during COVID-19
The construction and operation of buildings now causes almost 40 percent of global carbon dioxide emissions – as a result, numerous cities and states have passed CO2 emission laws for owners and developers of commercial real estate. In New York City, for example, Local Law sets 97 carbon emissions targets for any building over 25,000 square feet with no regulated rental units; Fines for not meeting these goals can run into the millions. So far, the legislature has rejected all demands of the real estate industry to slow down the implementation of these laws or to create other relief in the face of COVID-19.
These concerns had grown before COVID-19 highlighted the importance of improved (carbon-emitting) ventilation systems and limited landlords’ profitability. Retrofitting buildings across New York City could cost over $ 4 billion, and tenants are becoming increasingly sensitive to the cost of running additional operating costs.
Meanwhile, ever-increasing climate risks pose their own threat to CRE. An estimated 35 percent of real estate assets worldwide are exposed to climatic hazards such as floods and cyclones.
The central theses
- Pass-through costs – be it carbon fines or improved ventilation systems – are becoming a critical aspect of lease negotiations. For example, some tenants might argue that not every tenant should share these types of costs equally (e.g., other tenants will likely wonder whether the fines imposed on the building should be passed on to all tenants). Fines are also costs that landlords are often not allowed to pass on to tenants as an exclusion from operating costs. Landlords and owners need well-founded and experienced advice in these negotiations – especially in times of low demand for space.
- Landlords and owners should also stay informed of any legislative changes in the regions in which they operate. In New York City, for example, efforts have been made to amend Local Law 97 to make it easier to comply with emissions regulations. Although unsuccessful at first, these and other efforts can have a critical impact on the advancement of the commercial real estate industry.
4) Vaccination regulations pose new challenges for property managers
The impact of vaccine mandates continues to be intensively investigated. For example, if a tenant tells their property manager that employees need to be vaccinated in order to enter the office, how could this affect the outside contractor who is tasked with cleaning the premises or performing any necessary repairs and maintenance? Does the property manager have the contractual right to ensure that these employees are vaccinated? How could trade unions and collective bargaining rights be taken into account in these decisions?
The central theses
- Landlords need to be proactive in both contacting vendors about vaccine mandates and communicating with tenants. Tenants do not have the right to force external companies commissioned by the building to vaccinate. You can do without services, but as a rule you do not have the right to exclude contractors commissioned by the landlord from carrying out inspections or necessary repairs. Owners should also let tenants know if anyone in the building has tested positive for COVID-19 and what precautions and cleanings have been taken in light of this news. Every process taken on by a landlord must be implemented consistently. Landlords should also be aware that future rental and service contracts may contain provisions that enable a party to issue vaccination orders.
- Also, remember to be aware of potential HIPAA violations when disclosing information about cleanings and cases. In these cases, do not disclose names or information that could reveal a person’s identity.
5) Areas to watch in CRE
Despite ongoing pandemic-related challenges, there are opportunities in CRE. For example, the demand for logistics, industrial, data center, life science and multi-family developments was extremely strong during COVID-19. The question will be whether any of these areas are being overheated and overvalued – and consequently whether this could drive capital into other sectors (perhaps even back into offices as investors see office prices as depressed enough to offer an opportunity). For now, though, market fundamentals and discipline have by and large held out amid the pandemic.
The last 20 months have been a transformative time for the CRE industry and we are not out of the woods yet. Staying ahead of trends, making the necessary preparations for the future and reducing legal risks will be crucial in the uncertain months to come.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.