Managing in a Pandemic: Real Estate Developers on Immediate Challenges and Future Plans

April 20, 2020

By Kristen Lewis

The real estate market heading into the current crisis has sometimes been described as the “eleventh inning” of a tremendous growth cycle, so no one would be surprised if the economy’s COVID-19 whiplash had principals feeling anxious. EisnerAmper’s Real Estate Services Group recently convened a group of developers and owners to discuss what they are seeing, how they are coping, and what the future of real estate may look like.

While short-term concerns dominated the conversation, the group discussed the future of real estate, changes to their property strategy, and how the industry as a whole will come out of it. Here are some highlights from their discussion.

Tenants and Immediate Needs

Participants seemed to agree that on the residential side, the upcoming two months will tell a lot more about what the impact of the shutdowns will ultimately be, as rents for April were mostly on track the first week. One additional metric to forecast potential issues with collections in the future may be looking at how many tenants cancel auto pay options rolling forward. The implications will also vary by market and type of residential property as job losses cascade.

When it comes to rent collection, a wide array of potential arrangements are being considered and implemented for tenants in need, from payment plans, to extending leases, to potentially letting folks out of leases if they just can’t live in an affected area anymore. Others have been experimenting with discounts for rents paid on the first of the month or rent abatements. Some on the corporate rental side are seeing tenants asking for rent deferral or forgiveness.

With court cases expected to dictate how owners and operators can proceed with delinquencies, there is a degree of uncertainty in play about how these remedies will work. Developers are not sure which way the courts will rule – on the side of developers and managers, or to allow tenants more flexibility to get out of existing agreements.

Development

Deals in pre-development are moving along, however there are concerns that as the situation continues to develop, the appetite for certain projects may change. Construction has pretty much stopped, so companies will soon be forced to see how any failure to meet delivery dates plays out. The question looming over these projects: if dates get missed, will force majeure come into play? How force majeure will be interpreted by the courts is going to help put the deals into perspective in the future.

One potential effect of this marketplace may be longer periods for underwriting deals. Instead of a five-year exit, you would see more companies writing to a seven-to-ten-year exit. The days of shorter exits might come back, but not any time soon.

Vacation communities are in the news discouraging visitors coming from the cities, so some of those contracts for second homes/tourist properties may be cancelled.

Opportunity zones will be hit extremely hard because, by their nature, they exist in tertiary markets. The ten-year holding period may address some of that reluctance, so that developers can still entice tenants to move into those neighborhoods that had been seen as a bit of a risk prior to the QOZ program. Regardless of what happens in the near future, the feeling is that new developments will hold back quite a bit.

Sector Impact Differences

Participants so far are seeing more pain in retail rather than residential, particularly with “mom and pop” types of businesses who have been decimated by the shutdown. Many commercial tenants such as retail and parking lot operators are not paying rent currently, at least to an extent, with some owners asking them to do the best they can with payment. Real estate companies will monitor those metrics as shutdowns continue, as many continue to see this as merely a “pause” in the market.

The residential sector is also wondering how – and when -- the market is going to rebound, and to what extent. Developers with subsidized housing properties are more confident in eventual government payment.

In terms of asset classes, logistics seems to be a winner coming out of this crisis. It will be interesting to see what happens with the supply chain and logistics space moving forward. With expected changes on the horizon for other infrastructure in light of this crisis, that may be another area where projects will increase. 

The feeling among participants was that this crisis may well be the beginning of the end for shared workspace companies.

Hotels and hospitality properties will be in turmoil for a long time. While some customers will be chomping at the bit to travel once an “all clear” has been issued, there will be significant drawbacks. First, consumers will be struggling with the shutdown of the economy and job loss. In addition, there will be people who will be hesitant to get back into the swing of travel, wanting to avoid planes, large public venues, hotels, and more for some time. The hospitality industry will be tackling the issue of providing assurances that they can keep customers safe in this changed world.

Deals of the Future

Some companies are on the lookout right now for deals. Cash is still king – so serious discounts are expected soon. The price declines are seen as just beginning, and there’s a lot more data that has to come in for a proper forecast. Given that it’s not even possible to show properties right now, transaction volume is going to be pretty much zero for a while.

Some companies will weigh potential deals in this cycle against developments in science.  Long-term drivers for demand may change so much, particularly with office space, that it becomes a gamble. Shared workstations will be questionable rolling forward. And while some companies may see the WeWork fallout as an opening for new businesses to occupy that space, other believe that some WeWork locations were filling in less desirable space anyway, so that won’t be able to be easily filled in the future.

Patient investors can be flexible to wait for transactions to occur. There is very little data in the market at the moment because of the lack of post-shut down transactions.  Patience, on exits and acquisitions, is huge. In six months, we will see some amazing deals put together as the discounts are not there yet. Some companies are seeing discounts of just 5-10% in the multifamily space. For secondary markets, some companies think that when the discounts get to 15% and they get a better handle on cap rates and interest rates, there will be a lot of transaction activity.

Amenities

Developers believe that micro-units will stay, while co-working and living spaces will take a significant step back. That you can’t control others’ habits and use of the space, brings up the thought of the potential for your neighbors or colleagues to potentially endanger your life with their actions. And that kind of thinking throws cold water on the thought of hanging out together.

Technology Adoption

Real estate as an industry has been doing a lot of catching up on technology, and this crisis is making things develop even more quickly. Real estate companies are dialed into all these new collaborative platforms to get the work done, and the progress being made is amazing. After this situation is over, these technologies which enable more efficient operation and communication will be as an essential element of a good organization.

While some real estate companies will (ironically) ditch formal office space as remote working becomes more accepted, others see things going the other way. With even elderly and less tech-savvy clients figuring out how to take advantage of online tools (like DocuSign, for instance) which save companies time and money; the way we operate can become more automated. We’re simply looking at an accelerated paradigm shift. Time will tell what other innovations change the way we transact business post-crisis.

Future Trends

As for the future of development – A+ locations will be the only ones in play for office as demand factors change. Work from home will change office utilization, and office-use ratios will be different. Some developers also believe that there could be laws created addressing office density as well. Condo home ownership will continue to shrink. Increased demand for industrial space will continue in the future. Self-storage seems to be a great asset to have right now!

Other future trends? Some of the millennial generation changes are here to stay – meaningfulness of experience versus more space. People will put a premium on their time and experience. They will want to live somewhere where they can walk around, and yes, connect with their community. The world is seeing how they can work remotely, but there are still people who prefer a separation between living and working space.

This market is going to be very hard for millennials, the biggest customers for developers right now, so that will have a major impact. Smaller “starter” units will still be needed. The market will have, moving forward, an abundance of labor that we’ll be able to utilize for projects. There will also be more pressure to reorganize the economy to address inequalities as well.

We will continue to hold roundtables to share ideas, experiences, insights in the current trends and developments and hopes for the future. 

About Kenneth Weissenberg

Kenneth Weissenberg CPA, Tax Partner in Real Estate Services, is experienced in tax saving strategies and negotiating sales and acquisitions. He represents owners of some of the most well-known real estate properties in New York City.