View All ArticlesImpacts on the Real Estate Sector
March 23, 2020
A business-first lawyer with a finance background, Richard Coen has spent his 20+ years in the legal profession helping decision makers maximize profit and minimize risk. Often, business and legal considerations converge; Richard gets to know a client’s business and overall industry so that his legal advice is tailored to his client’s situation. Richard’s practice focuses on commercial real estate law, finance and public-private partnerships. His clients include real estate owners, lenders and developers in the acquisition, sale and leasing of all types of commercial properties. He regularly advises lenders in secured and unsecured lending transactions. He can be reached at rcoen@burnslev.com or 401.831.3010.
Coronavirus, or COVID-19, is having an enormous impact on global financial markets, including major implications for the real estate industry.
- Certain uses will be impacted more severely. As a general observation, commercial real estate uses requiring limited human interaction will likely fare better during and coming out of the COVID-19 crisis than uses requiring more personal contact. Self-storage facilities, data centers, and similar uses would be expected to weather the crisis more successfully, while retail, hotels, restaurants, conference centers, gyms, and other interactive uses will likely struggle (with the notable exceptions of grocery/food stores and pharmacies). Although manufacturing facilities, particularly those with advanced automation and more limited human involvement, could continue during the crisis, industrial uses that rely on supply chains involving COVID-19 affected regions will be exposed to more negative impacts. Tenants that are unable to access or use their space may seek rent abatements and other concessions. As discussed below, lease provisions governing force majeure will be closely scrutinized to determine whether rent or other tenant obligations may be suspended due to use limitations.
- Diligence and permitting efforts will likely be delayed. In a typical commercial property sale or lease, the buyer or tenant will have an opportunity to search title, obtain a survey, investigate the property’s environmental status, and conduct other due diligence. Online title review and recording are available in some, but not all, jurisdictions. As access to in-person governmental offices is curtailed, title review and recording may become limited, delayed, or unavailable. Surveyors, in turn, rely on title reports to depict pertinent survey information. Similarly, environmental engineers and others conducting standard due diligence may be unable to complete their work.
Further, the pursuit of permits at all levels will likely be delayed. Parties negotiating purchase and sales agreements and leases should ensure that due diligence and permitting periods (and any deadlines tied to those periods, such as closing) provide flexibility in the event that governmental functions are suspended or limited. Parties currently under agreement should discuss with their contractual counterparts, as well as with any lenders involved, any needed extensions, and other impacts on the deal due to delays in diligence and permitting. Parties should keep up to date on whether previously-issued permits having deadlines for commencement or completion of work are subject to tolling or other relief.
- Owners and property managers face operational challenges. Building owners and managers who become aware of a tenant who tests positive for COVID-19 have difficult decisions to make – potentially closing an office, a floor, or even an entire building. Further, upon learning of such test results, a landlord or property manager seeking to notify the other tenants in the building should be aware of the disclosure limitations of the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA). Even in the absence of onsite personnel testing positive for COVID-19, property managers may undertake more deep cleaning and sanitizing efforts than in the past. Landlords may seek to pass along the extra costs to tenants in the form of increased CAM charges. Tenants should examine their leases to determine whether CAM is fixed or otherwise limited, as opposed to being a direct pass-through from the landlord.
As more states institute stay in place and similar orders, property owners and managers should determine who will be in charge of the premises should a sudden shutdown be required. Building security protocols should be revisited in light of current developments, particularly in the event that a building or tenant space must be closed. It is also advisable to identify ahead of any mandatory closing what essential equipment (including computer control equipment) will be needed to maintain operations off-site.
- Key contractual issues. In addition to the other contractual implications discussed in this article, several provisions found in many commercial real estate agreements may be tested in the coming months. Force majeure provisions, as mentioned above, may provide relief to parties unable to perform. Even in the absence of an express contractual provision, the common law doctrines of impracticability and impossibility of performance may be available to a tenant or buyer. In general, impossibility may excuse an obligation that is physically impossible to perform due to unforeseen circumstances, while impracticability occurs when circumstances make performance of an obligation unreasonably expensive or burdensome.
Parties to real estate conveyance, finance, and lease agreements should determine whether the agreement contains a “time of essence” provision. If so, it will be important to initiate discussions with their contractual counterparts promptly if COVID-19 delays will impact timely contractual performance. Broad mortgage contingencies that are satisfied if the buyer can obtain financing “at prevailing rates and terms” may not function as expected, as lenders tighten credit terms. Other key contractual provisions that should be carefully analyzed include default and remedies provisions. Parties should also review what security may be available or at risk in the event of a default, such as a security deposit, letter of credit or guaranty.
- Lease terms will be scrutinized. Many tenants will closely review lease provisions, seeking relief from rent and other obligations. Leases that include rent as a percentage of sales will result in rent reductions for many tenants who see declines in business. Other tenants may pursue arguments under the previously-discussed force majeure provisions or common law doctrines. Beyond rent concerns, leases often require tenants to be open for business during certain minimum hours and days. Tenants should contact landlords to discuss how COVID-19 impacts may affect their ability to comply. Tenants may wish to review their leases for other potential relief, such as the ability to give back a portion of their space. Additionally, both landlords and tenants should be aware of lease renewal provisions. For example, some lease terms renew automatically absent notice of termination; now is the time to consider whether a renewal is intended.