Industrial Insider: The COVID-19 outbreak and its impacts on CRE Elise A. Couston, SIOR May 11, 2020 Share on Facebook Share on Twitter Share on LinkedIn Share via email As we work our way through these unprecedented and uncertain times, providing our clients with important information and potential options has become more important than ever. Elise Couston, SIOR Detailed below are some key issues that all occupiers of commercial and industrial real estate are currently facing. Force majeure Two of the most frequently asked questions that clients are asking about have to do with the force majeure clause and current rent obligations in existing lease documents. Tenants who are negotiating new leases or contracts should pay close attention to the force majeure clause and consider including “disease outbreak,” “epidemic,” “quarantine,” “acts of government,” “pandemic” and similar language as potential force majeure events. The force majeure clause generally permits parties to suspend or terminate their obligations due to certain circumstances beyond their reasonable control. In the context of COVID-19, it is important to determine whether the force majeure clause includes specific circumstances such as the above. If the force majeure clause includes broad general language such as “any cause whether similar or dissimilar to the foregoing,” it is likely to cover circumstances that are not specifically detailed in the provision. Tenants who are in leased buildings that have been directly impacted by government closures may view their leased spaces as being taken over by the government. Tenants and their legal counsel should see whether their individual lease addresses condemnation or eminent domain, and whether it provides any termination or rent abatement rights. Rent obligations Landlords typically have the right to deliver a notice of monetary default, and possibly the right to accelerate all lease payments with possible immediate recourse to guarantors and/or letters of credit. This action will require the tenant to defend its decision. It is important to note that some states currently have a moratorium on commercial (and residential) eviction proceedings. Due to the rapidly changing environment, discussions are typically being limited to 30 to 90 days. This time frame will enable landlords to monitor the situation closely and consider circumstances on a month-to-month basis. Most landlords are offering tenants who meet certain financial hardships a rent deferral instead of a rent waiver and adding the amount of the rent deferral as an extension to the lease term. Another option that landlords are contemplating is utilizing the tenant’s security deposit in place of a month’s rent, with the tenant repaying the deposit by a certain end date, i.e. the end of the year. All brokers should be advising their clients to check with their attorneys and lenders before offering any relief to confirm that it is permissible under the existing lease and loan documents. Almost all of the landlords with whom we have spoken are requesting a “rent assessment application” and current financial information in order to determine what type of relief, may be needed. Some tenants have been mandated by their CFOs to request some type of rent relief, whether it is necessary or not. Most landlords are not obligated to provide relief to any tenants who are in default. Tenants should seek assistance from government relief programs, if necessary. New trends One new trend that is currently developing in the U.S. as a result of COVID-19 includes the resurgence of “near-shoring,” whereby manufacturers may move their facilities closer to their final markets. In this scenario, Mexico may replace China as a major production hub due to its closer proximity to the U.S. Near-shoring offers an optimal solution for companies that want to outsource processes in order to maximize business efficiencies, but also reduce the barriers of traditional “off-shoring.” Compared to off-shoring, some of the benefits are that there is little or no significant time shift, fewer cultural differences, easier communications due to more people in the U.S. and Mexico being bilingual in English and Spanish and faster and cost-effective travel. Newmark Knight Frank recently provided a questionnaire to its clients. The responses highlight a variety of trends and issues relating to the impacts of the COVID-19 virus. Half of the investors who responded to the survey plan to focus on opportunistic deals this year. The responses showed that 39 percent of acquisition capital in the market is institutional, and another 28 percent is private equity. While some deals are currently on hold, the industrial sector has felt less of an impact than other sectors, and more robust market activity is likely to resume once the virus is contained. Nearly three quarters of respondents have not shifted debt strategies to longer-term holds, suggesting confidence that the current downturn will not be a prolonged event. Further, only 12 percent of respondents are seeing a significant uptick in shorter-term deals, with 58 percent seeing no uptick. Logistics firms are likely to evaluate the further use of robotics in their activities, possibly leading to new leasing requirements for modern facilities, as the industrial sector remains an economic driver in the period ahead. According to the survey, a significant portion—91 percent—of development projects under construction are still proceeding (35 percent with delayed delivery). The share of projects that are stopping could be a result of construction moratoriums in some cities, and those projects that are proceeding could be halted at any time by local governments, should conditions worsen. Finally, while no respondents are offering true rent abatement, 52 percent are offering their tenants deferment, 14 percent are offering a blend/extend strategy and 34 percent are offering a combination of these or other options including directing tenants to relief via the CARES Act. Looking ahead Geographic expansion in industrial markets seemed to be driving the demand for users, developers and investors prior to development of the virus. Industrial tenants, particularly the large users of warehouse/distribution space, had to choose from a limited number of modern, Class A options. The increased demand from e-commerce and other retail companies pushed industrial rents to new levels. Because of changes in the supply chain due to COVID-19, there is an additional uptick in demand anticipated from online retailers, which will result in the need for more warehouse/distribution space. Developers will likely continue to seek opportunities in more labor-intensive areas for last-mile logistics facilities, as well as those locations that offer multi-modal access. Secondary locations are also anticipated to become more popular in the next cycle as a lower cost alternative with access to alternative labor supplies. Another emerging trend is pharmaceutical companies ramping up their manufacturing efforts to expedite the research and production of COVID treatment options and ultimately a vaccine. According to the Wall Street Journal, companies such as Pfizer, Johnson and Johnson, Regeneron, Gilead, Moderna and others are shifting productions of existing medications to other global facilities or outsourcing those drugs to contract manufacturers to free up capacity for testing of new drugs and vaccines on a worldwide scale. Many companies will be hiring new workers over the coming months, and some will be expanding their manufacturing from two shifts per five days a week to three shifts per seven days a week. If there is any good news to report, most real estate experts predict that industrial real estate will be the first property type to recover from the current economic downturn due to shifts in supply chain demand and an increase in manufacturing closer to home. There is usually a way to make lemonade out of lemons in CRE, and this unprecedented time is a test of our drive to find creative solutions for our clients. Wishing everyone good health for you and your families, and discovering new ways to make lemonade. About the author Elise Couston is senior managing director with Chicago’s Newmark Knight Frank.