Real Estate and Covid: A Tale of Two Cities
April 20, 2021"It was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us."
The world of the late 18th century described by Charles Dickens in the famous opening lines of "A Tale of Two Cities" is analogous to the current state of the real estate market in the UK and the US, write Alastair Moss of Memery Crystal and Belinda Schwartz of Herrick, Feinstein LLP in this opinion piece.
The UK Perspective
It was as though Dickens had predicted the contrasting sentiments revealing themselves in the UK’s third lockdown (due to end completely on June 21st 2021) – both fear and hope – in equal measure.
The roll-out of mass vaccination with military efficiency, a deal to smooth Brexit, the comfort drawn from a change in power with our greatest ally across the pond and a pulling together of society into a common cause. Contrasted with the context of short dark days, loneliness, fatigue and the denial of education for many – and the monotony of what equates to virtual house arrest (at least till recently!) for the entire population.
Being a "people business", real estate traditionally runs high (or low) on sentiment. At present in the UK, the positive "can-do" attitude of those who build, lend and invest is evident, but increasingly strained.
Although leisure and retail re-opened on April 12, occupiers are on their knees. However, the services business, and particularly those located in the City of London and the major cities are doing well. There have been discussions between landlord and tenants trying to agree re-gears, rent deferrals, rent concessions and rent suspensions – some fruitful, but those unable to strike a deal have resulted in units (previously very much in demand) being left vacant. Manufacturing and logistics, tech and finance are all relatively unscathed. Resilience of the UK to continue working was vastly underestimated. Investment returns look on an upward trajectory, after the major dips of last year.
There’s sentiment, driven mainly by the press, that things will never be the same again. We will not need offices and leisure uses of real estate will have changed for ever. And people won’t want to live in cities.
The reality of course is that no-one knows, but most people are creatures of habit and also have an innate desire to be amongst others, to collaborate, create and coordinate. Most people are tired of Zoom and Teams. They eschew the idea that real human contact is no longer needed.
The UK real estate markets are reflecting a positive trend as people to look at where they work and where they reside, in order to get the best out of space and place. Working patterns are not likely to be in monotone any more – commuting at set hours and being fixed in one or two places will be very 2020.
The investment community is eager as ever to buy those assets that can be adapted to make this new space that fits the new normal, or that which is perceived to already be prime space to do that collaboration, creating and coordinating. We have noticed increased competition for the right assets, mainly in the office and logistics sector. This is amongst both domestic and international buyers.
In addition, very few occupiers have put themselves into insolvency in order to cease lease obligations. As a result, it’s a slow burn for any major change on how business occupies. Many leases have a few years left to run. Most businesses have stayed put, even if their premises have in some cases been out of action for a year now. There are a raft of government subsidies and moratoria that have kept the landlord and tenant relationship relatively stable, although on an artificial basis. The state-aid provided will need to be paid for and there are some concerns as to how.
Government policy to loosen planning controls and to increase the rights of those who lease their homes are likely to catalyse more action.
The residential development market, in particular taking inspiration from the US rental markets in PBSA and PRS, have been active throughout and no sentiment that the urban locations are less desirable has crept in. Allied with a very favourable tax incentive (potentially to be extended) on residential purchases has meant that the residential sector generally has done well.
Major banks are holding their nerve and not generally letting business in those leisure sectors fail. Other mid-market lenders and family offices are more than making up for any gap, albeit lending criteria are understandably tighter.
Real estate was a real focus for part of the recovery from the global crash 12 years ago, with the UK government making it a key part of the recovery. This crisis is likely to see a more sector-led response – to adapt to the rapid acceleration of change in the use of space. This will require leadership and clarity of vision from the leaders in the sector – if they can just pull that off, the UK real estate sector may come out of this better than when it went in.
The US Perspective
In the US, we are seeing "A Tale of Two Cities" in related but almost contradictory paths for the real estate industry – distressed deals and new deals. This is a very different situation than we have seen before, not only because of the black swan event that is Covid-19, but because this isn’t a typical recession environment. Currently, there are huge amounts of capital ready to be deployed within the United States and from investors into the US from overseas. Real estate investors, family offices and funds have large amounts of working capital they are looking to infuse into a variety of situations – but choosing the right scenario is where investors take divergent paths.
One of the current focal points is the distressed side of the market. Owners and investors are navigating the effects of Covid-19 through restructurings, workouts, attaining rescue capital and generally re-negotiating with players from lenders to tenants, and there are opportunities to be found. With reports that hotels and travel may not be fully back to pre-Covid levels for a number of years, owners and developers in this sector are looking into options for conversions. Retail and restaurants are working with landlords on solutions that may include percentage rent, rent abatements or other modifications of their leases. Offices and business districts are in flux as personnel continue to work from home. But while office workers value flexibility, colleagues will always need to gather, collaborate, teach and train employees, so the office market may see a quick turnaround for the remainder of this year. A good location, well-known brand or truly appreciated asset should hold its value and is worth a patient and thoughtful approach. While 2020 changed the game in U.S. real estate, creative deals continue to move forward on the distressed side.
On the flip side, there is still an appetite for new deals. Sectors like healthcare, industrial/last-mile delivery and multifamily have been active throughout the last 12-14 months, leading to re-zonings and development across the country. Regardless of the economic climate, savvy real estate developers and owner/operators want to participate in deals that will make sense for their portfolio in the long run. Funds and international investors are looking for a return on investment for their shareholders, and there is increased interest in development in newer markets across the U.S. as employers and workers think beyond the nation’s largest cities. Joint ventures remain a valuable way for clients to get larger multi-million dollar deals done; we have been seeing increasingly complicated capital stacks well before 2020. Family offices have an extended timeline for investment, planning now for grandchildren or great grandchildren of the current generation. Deals are getting done and the appetite is there for new deals in both new and established U.S. real estate markets.
The "tale of two cities" is so apparent that we are even seeing these two different strategies playing out at the same company, where one division is investing and leveraging opportunities with distressed assets while another is looking for opportunities to deploy capital and continue to execute existing growth strategies in new deals in growing or established markets.
For all of 2020, and now the beginning of 2021, challenges and opportunities for the entire real estate industry abound.
At Memery Crystal and Herrick, we look forward to collaborating with the international real estate and business communities as we move forward and onto new projects and new developments in 2021 and beyond.
About the authors
Alastair Moss: Alastair Moss co-heads the real estate team at Memery Crystal and has practiced as a property lawyer for over 20 years.
Belinda G. Schwartz: A 30+ year veteran of New York City’s commercial real estate market, Belinda G. Schwartz has chaired the real estate department at Herrick, Feinstein LLP since 2014.