Steps for Landlords Amid the COVID-19 Market Contraction
We know everyone is anxious in these times of uncertainty. At TRA, we want to assure our clients that we are equipped to support our clients in the same way we always have. That being said, we are sure that the commercial real estate community has lots of questions about what will happen in the intervening weeks and months as companies grapple with the economic impacts of the COVID-19. Our initial thoughts are outlined below. We will keep a watchful eye on both markets and regulators and inform you all of what changes you may expect.
The Short Road Ahead for all of Us
Many of us are now working from home (don’t forget to change out of your pajamas), schools are closed, and the hospitality industry is all but shut down. Since many of us are confined to our homes, we are no longer engaged in the small everyday transactions that move money around the economy. Transit systems will report lower ridership, coffee shops will sell less caffeine, and delis will make fewer sandwiches. These small transactions are a part of our lives, and without them, the movement of money begins to slow. This movement will be compounded every day as we engage less and less with one another.
Enter the Federal Reserve. A few weeks ago, we wrote about its initial rate cut indicating that it may leave the Fed less prepared for a broader slowdown. Over the weekend, the U.S. Federal Reserve went ahead and cut rates to near zero and announced it would increase government bond repurchases. This is taken from the financial crisis playbook, and it is meant to provide added liquidity in the market. This is not a normal economic crisis. Our economic system relies on the movement of money, and interest rates are the Fed’s primary tool. The Fed is not only concerned about the economy though. It also needs to preserve our financial system, and there are early signals that all is not well.
Demand for repos is down which means that even though banks have access to liquidity, they don’t want it. Tepid repo demand could be a signal that there is no demand in the market for bank funding at the moment. This is a normal early reaction as we all try and assess what is happening. If this demand remains low for a prolonged period of time, it would be a fairly clear signal that the financial system is under significant pressure and not just the economy. For now, we will simply have to wait and see.
The Long Road Ahead for Commercial Real Estate Sector
Our economy will almost certainly contract based on our response to the virus. The good news is that we are all in this together, and we will pull each other up. So what should we be prepared to see out there (assuming no government assistance)?
Many small companies keep between two and three months of cash on hand. Absent any support, it is within reason to expect some of these companies to fail. Some will reduce headcount just to keep the business solvent. And some will make it through with limited long-term harm.
Many medium and large companies have utilized leverage to fund growth and sustain operations. These companies are at increased risk of default, even with reduced rate interest exposure. Lower demand will lead to lower revenue which will pressure loan covenants and interest coverage. Since there is nowhere to hide, banks will likely be more willing to grant waivers and exemptions for borrowers not in compliance with loan covenants or who miss interest payments, but the debt will not simply be forgiven. The obligations would likely be renegotiated.
If and when the government does step in with assistance for individuals and businesses, there will be a long-tailed recovery. Growth assumptions going forward will be tempered by raw material and other supply chain disruptions. We are less likely to be able to spend or consume our way out of the recession as savings will be materially depleted. Governments and central bankers the world over will be working to get money moving through the economy again and thinking of ways to get people on their feet. That will all take significant time, and we will once again find ourselves borrowing against the future to fund the recovery.
What the Commercial Real Estate Sector Can do Now to Prepare
Now that you probably have some time on your hands, let’s explore some steps to head off the calls for help from your tenants that will invariably come in the next few weeks. Some tenants will seek rent relief during this time. Landlords should be prepared for this scenario on a portfolio level. They should implement a process to evaluate each tenant seeking relief, be it a retail, office, or industrial tenant. Landlords should establish thresholds based on debt service and fixed cost coverage to ensure they have sufficient cash flow at an asset level keep the lights on. Create financial and business model tests for each business to determine whether or not to grant relief to these tenants that are lenient enough to allow all but the weakest to remain in their leases. Keeping businesses in place will help position all of us for the best possible outcome, whatever that may be. Now is a time to be generous with one another and to show solidarity with your tenants. Be prepared with answers to their questions and offer them a roadmap. It is important that we get through this, and is possible only if we all work together.