All disasters have three stages – the assessment, the repair and the on-going phases – we are in the assessment phase, but we may still be assessing the assessment.
There are three types of recovery – a short V, a long U and an L. Bell says that from studying detrimental conditions since the 1980’s, in most markets he expects a V recovery, where distressed owners sell and drive the market down, followed by a steep recovery. Some are forecasting a W shaped recovery, somewhat similar to seasonal ups and downs, if COVID re-emerges and the economy pauses again. No matter the type of recovery there is light at the end of the tunnel.
In the commercial markets, those REITS and landlords who have good management and proper reserves will go through this relatively unscathed. He predicts cap rates will likely surge about 2 points due to distressed sellers. Distressed players will go away while blaming the coronavirus, however they likely were on thin ice anyway.
From a recent Co-Star survey, Office leasing is beginning to rebound but still down from previous years. A study regarding planning for the reimagined workplace shows a significant increase in the number of employees working from home 1 year after COVID-19. Buildings with elevators present a significant challenge due to limited capacity requirements. The premium rates the CBD’s currently experience could be difficult to continue. The greatest remote preference is a hy-bred of at home and at office. According to the CEO of Blackrock he feels a maximum of 60-70% of their employees will need to return to the office. This has to impact demand at some point. We are blessed to have the Medical Mile activity we do, which was recently improved even more with the announcement Perrigo was moving into a new facility they will build downtown just off Michigan. Medical offices currently lead the commercial real estate industry, with rent collections at 99.8%, in spite of some tenants having faced challenges amid the banning of elective procedures.
Bankers I talked to have stated the small guy, highly leveraged, may be in trouble, but the original panic seems to have diminished. In general, they stood back and watched for the first three months with no new loans, but are now back looking for business – lower interest rates have certainly helped.
Again, the reoccurring theme is ‘Property and Location Specific” regarding impact, with good locations and quality tenants not significantly impacted at this point.
Retail seems to be the most difficult area, although again “Property and Location Specific” is key. Nationally it has been hard hit – published sales data shows lower incomes but creeping up after July, primarily from on-line sales. E-commerce was approximately 13% prior to the pandemic and 18% now. E-commerce is growing quickly and taking demand away from on-site shopping.
Slower recovery from malls that are designed for crowds which is not good now. 50% of all closures are coming from malls even though they make up only 10% of all space. The expectation is mall vacancy will rise by at least 4% which will impact its value. Malls will also have a slower recovery while neighborhood and community centers should hold up.
Restaurants – could be tough going and 61% of the closures are likely permanent!
Quick Service Restaurants (OSR’s) has seen an increase of 30 basis points in cap rates nationally compared to past years, with corporate leases basically unchanged. Many OSR’s are looking to downsize their sit-down stores and look for drive-through sites. There will be a bifurcation between corporate/large franchisees and smaller franchisees as a flight to quality continues.
Bankers have mixed emotions about retail – many stated they are not seeing enough data yet and some appraisers are making 5-10% downward adjustments on some properties. Sit down restaurants are hardest hit and if they make a loan, they are looking at a 12-month period to stabilize the income. Another said retail was a flip of the coin – national tenant restaurant would be okay. Smaller mixed tenant facilities would depend a lot on the owner, local, amount of leverage, etc.
Most fast foods are still paying – PPP helped and deferments are good through 12/31/2020 with no consequences and no downgrade of the assets on their books. In March 40% asked for deferments and that is now down to 15%.
Industrial seems to be holding up fine and actually improving. The Grand Rapids area is growing pretty rapidly and our diversified industrial base has proven to be a very positive factor.
Multi-family continues to be a significant factor in new construction and resales are good, with some paired sales showing significant increases from previous years. The demand for these facilities is boosted by the lack of inventory of single-family homes and the builder’s inability to keep up with demand, especially in the lower, entry level price ranges.
We are blessed to be in the West Michigan area at this time, as the infection rate on this side of the state is substantially lower than the state as a whole. Let’s hope that continues and a vaccination is developed soon so we can move past this current situation.
John A. Meyer, SRA, GAA
John A. Meyer Appraisal Co.
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1. Amortize the missed payment amounts over the remaining term of the lease. This is perhaps the most common method to deal with a COVID-19 payment deficiency. Rather than attempt to evict the tenant or seek any sums owed following the expiration or termination of a lease, the parties instead take the missed payments and roll them into the remaining amount owed for the duration of the lease and then raise each payment accordingly once the tenant has resumed operations. For example:
Tenant missed three rental payments at $5,000 per month during the COVID-19 shutdown for a total of $15,000. Now, tenant has reopened for business and has 18 months remaining on its lease. 18 months of rent at $5,000 totals $90,000. In this scenario, landlord would add the $15,000 to the $90,000, which totals $105,000, and divide that by 18 to determine the new monthly rent payment for the remainder of the lease term, which would be $5,833.33.
If the parties choose this option a lease amendment should be executed to memorialize the agreement in writing and to reflect the new monthly payment. Although a separate repayment agreement may also suffice if carefully drafted.
2. Enter into a short-term repayment agreement. If either party does not want to amortize missed payment amounts over the course of the remaining term (especially if the lease has a lengthy period remaining), then a short-term repayment agreement may work better. For example:
Sticking with the above example, tenant missed three $5,000 payments totaling $15,000. But here the parties would instead agree to pay the missed payments off much sooner. In this scenario, tenant would pay larger amounts each month to makeup the COVID-19 rent shortfall. Terms can vary, but for illustrative purposes, the parties could agree to have tenant pay an additional $2,500 to landlord each of the next six months. That means that tenant would pay $7,500 per month thereby paying down the rent deficiency in six months. Then tenant would go back to paying $5,000 per month for the remainder of the lease term.
For parties selecting this method, a separate repayment agreement will work if carefully drafted. Although the parties may still feel more comfortable executing a lease amendment.
3. Forgive all or a portion of the rent for the term the tenant was unable to operate. While this option may not initially sound like a win-win (at least to landlords) it still may be a good option for both parties. While rent forgiveness will certainly reduce the pressure on a tenant to come up with funds to pay rent for a period the tenant was not permitted to operate by governmental order, it may also build a great deal of goodwill between the parties. Some tenants may be in lines of business that are not yet permitted to reopen or are operating at a reduced capacity, while others may struggle to ramp their sales back up to pre COVID-19 levels. Not to mention that evicting an existing tenant (especially a trustworthy, long-term tenant) and attempting to find a replacement can be costly to landlords. Perhaps even substantially more expensive than simply forgiving all or a portion of the rent payments missed by a tenant due to COVID-19. As such, depending on the circumstances, landlords may want to consider this option to avoid a costly re-leasing process.
The options listed above are just a few ways for commercial landlords and tenants to attempt to work through nonpayment lease defaults resulting from COVID-19. Whether you are a commercial landlord or tenant, you can contact me to discuss these options and other unique solutions for dealing with COVID-19 related issues. You can email me at firstname.lastname@example.org or call me at 616.458.3600.
However, these advances do not come without potential consequences such as the impact on employment. This risk is often referred to as technological unemployment. Artificial Intelligence (AI) and Augmented Reality (AR) advances are no exception and do not go without unemployment risks for many industries in the service sector including the CRE community.
If you were born before the early 80’s, you probably remember when Marty McFly first took the DeLorean to California where he landed in the future year of 2015. He flew around on a hover board (while escaping Biff Tannen), wore an automatically drying jacket and thought we was going to be eaten by a great white shark hologram.
Some of these futuristic advances may be slightly behind, but the Augmented Reality (hologram scenario) is quickly making its way into many major markets around the world. In the day and age where companies obtain value through monitoring our purchases and habits, retailers are already using new technology for facial recognition so they can identify shoppers for a variety of reasons.
At a recent CRE tech conference, the prospects of AR advances left many brokers wondering how their future revenue stream will be affected. We were shown many platforms that are already in place at many large markets worldwide and also some that will be hitting mainstream after a few more small advancements. We witnessed AR glasses which allowed shoppers to view “pop out” advertisements while they walked down the street (some tailored directly to them due to facial recognition). We also saw high-rise buildings with huge AR banners on them. This lends the question as to who has the rights to the revenue stream from that advertisement and will the building owner even be aware. How will this advancement change the value of these high-rise buildings? Though there are certainly negative views on these advances, some are embracing it due to the sheer efficiency and experience they receive.
Specific to real estate and the advisors in the room, we witnessed AR glasses which allowed for an individual to look at a building and see a variety of factors such as vacancies, occupants, rental rates, building efficiencies, building amenities and much more. What caused the bubble in the room to deflate was when a video popped up showing a hologram real estate agent who was taking a client on a tour. The prospective lessee was able to put the glasses on and receive a guided tour of the city and specific buildings, where this individual could see which spaces were available to them and were even able to walk into the space and project possible finishes and buildouts real time. All without a real-life real estate agent.
As with all service-related jobs, we have to bring value to the end consumer. Even more so with these technological advances, real estate experts need to think beyond the box to strategize how they will continue to bring value to clients. One thing that it doesn’t appear AI or AR will be able to compete with (as of now) is the emotional intelligence of humans.
Approaching the new year, what is of importance to commercial Realtors and their clients? The easiest answer is the size of the market, which has gone from approximately 350,000 registered Michigan Medical Marijuana caregivers and patients to 9.9 million people for Adult Use (sometimes called “Recreational”). It’s the same plant as sold for medical marijuana. It doesn’t know the difference; it just has an expanded market.
With the expanded market now, there’s a tremendous demand for viable licensable properties. People interested in the marijuana industry are everywhere searching for locations. You need to learn which municipalities will allow which Medical Marijuana and Adult Use activities, how licenses are awarded, and how to creatively structure offers and leases, often pending licensing approvals.
Some other highlights and thoughts you need to understand for 2020:
• Municipalities still control their own fate. Are they in or are they out? They can be in, to a limited extent, by limiting the types of facilities and numbers of each (currently, there are only a handful of municipalities allowing adult use).
• We foresee a significant increase in the number of municipalities which will allow Adult Use facilities over the next year. Find them! Many of those municipalities indicated they wanted to wait to see what the Adult Use rules are. Emergency Rules have now been adopted. Municipalities are often slow to react and the leaders reluctant to leap into this arena until they see their neighbors taking advantage of the opportunities presented by these facilities. Unless things radically change, these facilities are not expecting tax breaks or money from the MEDC. They pay their full share for a fully taxable piece of property.
• Besides the usual Grower, Processor, and Retail Sale licenses, there are others under the Adult Use canopy which Realtors need to learn about as their clients may want to take advantage of them. These include:
o “Consumption Establishment.” In parlance that’s a “smoking lounge.” Put those adjacent to restaurants, event facilities, or at a golf course. Make it like a video arcade?
o Marijuana Event Organizers. If your client has a large open space such as a field, a mall, or a parking lot, what about having a temporary marijuana event at that location? There are the obvious places like music festivals. People can come, buy merchandise, and smoke at the event. It’s doubtful we will see it on Calder Plaza this summer, but one never knows. What about at a football or baseball stadium?
o Delivery License. This license is not yet available. It’s in the proposed Rules and we expect it will pass. This will allow a delivery service to take product from the retail shop to an individual’s residence. It is not a secured transport and essentially replaces the requirement that home deliveries be by an employee of the retail entity.
• We also predict, which will be the impetus for further tremendous increased expansion in the industry, that the two-year lockout of non-MMFLA licensees is reduced to one year. Right now, the MMFLA licensees who are getting Adult Use licenses have that two-year protection from November 1, 2019. The change, if it occurs, would mean that any applicant could get the major Adult Use licenses beginning November 1, 2020. This is my prediction. I have no substantiation for it other than just my experience in this industry and reading the tea leaves.
What should Realtors do if they want to work with businesses in this new field?
1. Help their clients understand the municipal ordinances which grant marijuana business opportunities, including restrictions on license numbers, locations, and buffer zones.
2. In evaluating possible locations for their clients, understand the costs associated with such a development and the length of time required for construction/build-out and the license process.
3. Recognize that property values are constantly changing in this new world of marijuana business as more municipalities jump into the business arena. Costs for electricity, water and transportation through a Secured Transporter play significant roles in determining value.
4. Since this is a cash business, understand the requirements of Currency Transaction Reporting (Form 8300) for those receiving cash payments. This includes landlords. Recording requirements relate to “a series of transactions,” not just to each individual payment. If you are a landlord or property manager, it will be best if you understand its requirements.
5. Learn the future of the industry so that you can help your clients best evaluate options and opportunities for initial operations, optional licenses, and expansion opportunities.
The “Wacky Weed” dominates the real estate market as a new year and a new decade dawn. Realtors take heart; the expansion of this new growth business has just begun. Opportunities abound for those willing to learn and work.
Cannabis keeps on growing.