The real estate industry faces COVID-19: Options for landlords, REITs and more

Byron Carlock, Jr. Real Estate Leader, PwC US April 27, 2020

Several real estate trends have been emerging over the past few years, including working remotely, the continued rise of ecommerce and de-urbanization. COVID-19 has accelerated these trends, which were on track to play out over months or years but are now happening in weeks or even days. In our discussions with real estate clients, three key issues keep coming up: rent shortfalls, financing challenges and disruption in securitization markets. Here are our thoughts on how to approach each challenge.

Renters are missing payments on a massive scale

Consumers are facing tough decisions about which bills to pay first, and many have decided that rent isn’t at the top of the list. In fact, one-third of US residential renters missed their April rent payments1. Here are some solutions that landlords, real estate investment trusts (REITs) and real estate firms should explore:

  • Residential landlords should help their tenants get the government benefits for which they qualify. For example, we recommend proactively sharing information on the CARES Act’s expanded unemployment options with their tenants and then discussing a possible plan. 
  • Commercial landlords should discuss with their tenants loans provided by the CARES Act and any other assistance landlords can provide.
  • Now is the time for property and mortgage REITs to work with their lenders on the terms of their debt. Negotiating now could make restructuring or bankruptcy a last resort.
  • Aside from assessing the direct lending support provided by the CARES Act, real estate firms should explore the variety of tax benefits available. CARES Act tax benefits include changes in interest deductibility, technical corrections for expensing and depreciation of qualified improvement property, and extended limits on net operating loss (NOL) carrybacks. These can directly affect cash flows by allowing firms to access tax refunds.

Financing markets have tightened

Real estate industry participants are facing increasing pressure due to the volatility in financing markets. As property values fall, many firms may face margin and collateral calls, and some are already facing a growing cash crisis. Here are some suggestions for tightly managing cash flow:

  • Real estate firms should think beyond typical cash management measures (such as lowering expenses). Some may even consider strategic asset sales to generate cash quickly.
  • Hospitality companies may need to consider restructuring loans and management agreements related to their properties in light of low occupancy rates.
  • Certain REITs need to carefully monitor their tax status and covenant compliance when deciding whether to apply for government programs or take other actions to help maintain liquidity. For example, REITs must distribute 90% of their ordinary taxable income each year. In the current environment, some firms may be tempted to conserve cash and limit their distributions, which could call their tax status into question.

Securitization markets have been upended

Firms that were already squeezed by other market forces are discovering a new challenge: Spreads on real estate securities have been widening, despite actions by the Fed. Firms should be proactive and forthright in how they address these concerns, including by considering the following actions: 

  • Real estate firms could look to nontraditional liquidity sources, such as private equity (PE) investments. With a large amount of dry powder at their disposal, PE firms may be willing business partners.
  • REITs may want to pursue capital transactions, including joint ventures and other partnerships. Exploring M&A transactions may not be out of the question for some firms. 
  • Participants in the real estate industry will want to make good faith efforts to resolve financial issues created by the COVID-19 crisis. Debtors tend to be in a better negotiating position if they make at least partial payments.

What does tomorrow have in store?

Once industry firms tackle the immediate issues created by the crisis, they will need to deal with longer-term strategic questions, including:

  • Companies should rethink office design and workplace configuration. For example, even after offices reopen, many companies will likely have a higher percentage of remote workers than in-office staff. However, this doesn’t necessarily mean the firm will need less physical office space. Some firms will enable social distancing through changes to office density and cleaning procedures, including germicidal treatments. Workspace screenings could become more commonplace, and could include technologies, such as facial recognition security systems, that incorporate temperature assessments and digital platforms that enable automatic contact tracing
  • COVID-19 will likely cause changes to future urbanization trends. What started as short-term demand shifts in hospitality, retail, restaurants and offices could lead to broader changes later on. Investors may want to pay closer attention to opportunities in suburban or rural locations.
  • Commercial rental prices may fall because of the unanticipated surplus of unoccupied space. This could impair long-term cash flow growth and property values, especially as individuals and companies rethink how they work and shop. Firms may want to reexamine their capital structure.

As cash flow, financing and securitization options constrict, the real estate industry faces critical decisions, so leaders need to take steps now that will help expand their options and put their firm in a strong position for the long run.

1. Will Parker, “Nearly a Third of U.S. Renters Didn't Pay April Rent,” Dow Jones Institutional News, April 8, 2020, accessed via Factiva, April 8, 2020

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