Post-Pandemic Planning: A Guide for Real Estate Family Businesses
March 03, 2022
By Joseph Rubin
As we look forward to our emergence from the devastation and tragedy of the pandemic, all Americans are dusting themselves off and thinking about the future. We are all restarting our lives, making plans and perhaps using the lessons of the pandemic to change our priorities and behaviors going forward. Businesses are also regrouping, considering new strategies and directions, and a new approach to bringing employees together and creating culture. These changes are especially relevant for family businesses, where personal and business goals often intersect.
Real estate family businesses are particularly intertwined with family dynamics, and many are pivoting their strategies and operations in response to new patterns of demand for residential and commercial space, and the new risks and opportunities of real estate ownership. The economic and behavioral fallout from COVID-19 has had varying effects on each market, property type and building. As such, each real estate family business has experienced and is likely to continue to experience different challenges.
As we begin 2022, the time is right for family leaders to consider how the well the business has performed during the past year and what lessons could be learned, particularly in the way the family communicated with one another as critical and often complex decisions were made to preserve asset values and manage risk. This article provides guidance on areas of focus when rethinking both family and business matters in the post-pandemic real estate environment.
Reassessing investment strategies
Real estate owners have recognized that the pandemic shifted the demand for space across property types. Multifamily properties in gateway cities reliant on public transportation saw a significant out migration of tenants, not all of which have returned. The pandemic accelerated the move of older millennials to the suburbs, and even before COVID-19 struck, new rent regulations in states such as California and New York made it more difficult to achieve required returns from apartment renovations. The oversupply of retail in many markets became even more pronounced. And the strength of office space demand remains uncertain as tenants experiment with more permanent work-from-home (WFH) or hybrid scenarios in what is certain to be a years-long experiment. Hotels suffered the most immediate impact of the 2020 lockdowns, and while leisure travel has returned, the restoration of business and group travel demand is still impossible to predict. At the same time, many owners are selling industrial properties and Sun Belt apartments as investor demand makes offers too rich to refuse. And no one knows the course of the pandemic as each new virus variant circles the globe.
These new, fast changing, and often volatile market dynamics require refreshing real estate company strategy. Many owners are looking to new markets to find better opportunities, changing their investment targets to new property types, planning to repurpose space or searching for elusive distressed situations, or selling portfolios. Such strategic shifts can only be successful if the company has the right platform—local relationships, access to data, analytical tools and reporting, and capital availability—to optimally implement the changes. Companies are also taking a hard look at their existing portfolios, reforecasting budgets, modeling prospective cash flows and capital requirements, and potentially adjusting expected returns.
A key consideration in buy-hold-sell decisions today is a property’s ability to hedge against inflation; that is, whether the owner can increase rents along with or exceeding the inflation rate while managing expenses. An assessment of property competitiveness and actual-versus-market rent variances in the current environment will become even more important in the next few years. While many management companies have made substantial progress in improving operating efficiency during the pandemic, they are fighting the headwinds of steadily higher costs in construction materials, mechanicals/appliances, and labor. Budgeting operating and capital expenses in an inflationary environment with supply chain disruptions and worker shortages will be challenging for both acquisitions and asset management.
Another consideration of heightened importance is whether the family business has devoted sufficient attention to the environmental, social, and governance (ESG) requirements of growing numbers of capital sources. A LEEDS certificate in the lobby is no longer enough. Investors are concerned with both reducing the portfolio’s carbon footprint and knowing the company has drafted principles and policies that provide equal opportunity to a diverse group of employees and benefit the community at large. ESG is changing the way all companies operate and communicate their efforts, creating accountability for vendor selection processes, employee advancement, tenant safety measures and, of course, carbon-neutral building designs.
Early in the pandemic, the greatest concern for property owners was liquidity as cash flow was squeezed by lower rent collections. Many owners were forced to seek forbearance agreements from their lenders to bridge the liquidity gap, and some families had to put additional capital into the business. Today, depending on the property type, much of the liquidity crisis has been resolved. The debt markets are fully open, although lenders remain skittish about office, retail and hospitality and underwriting standards have tightened. However, some companies are still paying on modified terms and must refund reserves. Others have maturities coming up in what will likely be a rising-rate environment. All this points to enhanced vigilance on cash budgeting, monitoring loan covenant compliance and preparing for loan maturities.
Of particular concern in real estate family businesses, cash shortages often translated to a partial or full cut in distributions paid to family members and limited partner investors. Accordingly, company management should be updating their cash flow models, projecting revised short-term and longer-term income streams based on revised rent and occupancy assumptions, anticipated collection of past due rent, operating expenses, capital budgets and debt payments. In this way, owners can effectively communicate and proactively set the expectations of family members, outside investors and lenders.
While the pandemic was raging, we also witnessed the increased volatility of our environment, with continual news of heat waves, intense storms, flooding, and wildfires. The resiliency of the real estate assets given climate change is now a top priority of all property companies and their investors and lenders. Performing an assessment of property vulnerability requires an understanding of environmental threats to the market and a property’s location within that market. Investments required to more safely house the building’s mechanical system, protect against water damage, and better heat and cool the interior must be added to the near-term capital budget and considered in cash projections.
The pandemic also brought to light two areas of required focus for real estate business leaders: fraud prevention and cybersecurity. Studies have shown that real estate recently has had the second highest median fraud loss of any industry. Family businesses often do not have the same internal control and fraud prevention processes as institutional players. Further, the internal control environment can be weakened when employees are working from home. The stress caused by the pandemic, furloughs and pay reductions all have the potential to motivate employees to commit fraud.
All companies, irrespective of size, are vulnerable to cyberattacks. While not new, there are increasing numbers of publicized successful attacks on what would be thought of as companies with enhanced security. As family businesses implement more property technology alongside management and accounting software, they also have to invest in security platforms to control and protect the entire IT environment. Additional oversight, enhanced training (most security breaches result from unintended employee actions), avoidance and protocols for ransomware are all components of an effective IT security plan.
The challenges all families went through in the last year emphasize the importance of empathy and good communication. That is equally true in a family business, particularly in real estate, where property ownership is often shared among many people. Frequent family meetings and enhanced reporting can be used by leaders to explain changing strategies and the rationale for critical decisions that impact family members, including distributions. The more information that can be shared, the better—to preserve family harmony and avoid conflicts during difficult periods. It is possible that during the pandemic some family members had conflicting views on how the company should be dealing with tenants, vendors, lenders and investors. Providing a forum to air dissenting opinions and formally resolving such disputes can strengthen family bonds and avoid on-going resentment. Behaviors during the pandemic may have reinforced the need to create or refine family governance, including delegations of authority and reports with richer information.
The past year also stressed the need for enhanced emergency preparedness protocols. Tragically, some families may not have been sufficiently prepared for a sudden leadership succession, both within the family and among management company employees, and difficult decisions had to be made in the midst of the storm rather than during a period of calm waters. Family meetings afford the opportunity to assess skill sets and have honest discussions about the future leaders of the family business.
The realization that family members’ health or even lives could be vulnerable to sudden events outside their control is unsettling, and part of emergency preparedness is creating a “desk plan” for all members of the family. A desk plan organizes the information required if a family member dies or is incapacitated. It provides a roadmap to important information and documents that are essential for an easier transition during a difficult time. A typical desk plan includes the location of contact information, passwords, estate documents and investment account statements. For a real estate family, the desk plan should also provide access to property performance data, management contracts, lease databases and critical financial records. The availability of these documents will enable the heirs to maintain operations and mitigate any risk of business interruption.
Action steps: the post-pandemic checklist
As you move forward from the pandemic and consider the future, have you taken the following actions for your business and your family?
- Refreshed your business strategy
- Assessed the adequacy of the business platform to support the company’s new direction
- Reforecast property budgets and assessed cash needs
- Analyzed the potential for refinancing loans with near-term maturities
- Identified potential operating expense savings
- Assessed the adequacy of internal controls
- Competed the Real Estate Fraud Prevention Checklist
- Analyzed ways to reduce the carbon footprint of both the company and its portfolio
- Conducted a formal assessment of the portfolio’s vulnerability to climate change
- Created a statement of ESG principles
- Held a family meeting to discuss the company’s performance during the pandemic
- Reset family member expectations about investment returns and cash flows
- Refreshed the family’s governance documentation, including succession plans
- Considered ways to enhance family communication, including regular reporting
- Developed emergency preparedness plans
- Encouraged all members of the family to prepare a desk plan
- Updated your estate plans