CRE state of play amidst COVID-19

By Mark Lewarne, head of real estate & workplace strategy at HubbleHQ 

The Commercial Real Estate (CRE) sector has had some ups and downs over the years, but nothing could have prepared it for the unreal scenario currently confronting us all.

On Tuesday (23 March), the government made two significant announcements: firstly, that only essential workers should attend their place of work, and secondly that for a three month period, landlords would be unable to evict tenants if they were struggling to pay their rent due to the Coronavirus crisis. The latter point would be enshrined in a new Coronavirus Bill being rushed through parliament.

This latest twist is yet another adjustment the CRE sector is trying to make in a rapidly evolving landscape—up to the middle of March things were fairly normal; busy buildings with companies going about their work, albeit with a feeling that something was about to change. Since then, everything has rapidly escalated. London’s offices have emptied, the schools have closed and social distancing is not just advised, but compulsory.

Landlords and workspace operators are now immediately confronted with two difficult decisions. Firstly, whether they should stay open or not. This might seem like an obvious answer given the edict from Boris, but companies have very different interpretations of what work is “essential” (see Sports Direct), and what if you are a serviced office with a division of the NHS or a support charity in your building?

Secondly, and in respect to the announcement on evictions: what exactly constitutes “difficulty in paying rent”? And what happens afterwards…does the rent become immediately due after the three months, or is it deferred further with payments spread through the term? What is the impact on your deposit? What will the effect be on the validity of future break clauses? And should the lease term automatically increase? Answers on a postcard, please.

If you’re a flexible workspace operator, it’s even more complex. If you are leasing the building, you are likely to be in a dialogue with the landlords about deferring or reducing your payments (IWG plc announced they were doing this earlier this week). Then, if you are successful, do you pass that down in full or in part to your occupiers (or not at all)? If you have closed the building then Empty Buildings Rates Relief will kick in—but currently, that’s only for three months.

For tenants in leased properties the first quarterly payment date on 25th March is upon us, and many will be wondering whether to pay their rent, abide by the covenants in their lease and hope that they will receive some sort of benefit from the government at a later date, or alternatively withhold rent and rely on the announcement to protect them. The timing of the announcement was perhaps not a coincidence.

The single biggest problem for both landlords and tenants is this—no-one knows what the timetable is. We could all be back at our desks in May…but you wouldn’t bet against it being December. Of course, the longer this goes on the larger the group of tenants that will be coming up to the end of their leases or licenses. And then what? Renew? Walk away and work from home until things are more certain? Downsize to a smaller office? All of these things will be occupying the minds of business owners and CRE professionals over the coming weeks.

For flexible office providers, the crisis is probably more acute. Their tenants are typically on shorter contracts, which could spell trouble if the crisis lasts for longer than six months. There is also now huge uncertainty about when commercial life will get back to normal—and the longer this crisis continues, the greater the risk of business failure, despite all the support from the government. Even for solid traditional landlords, what might have looked like a blue-chip company with a strong covenant three weeks ago may suddenly be a business at risk, especially if their business is in the hospitality, travel or leisure sector.

And it’s not only the risk of default concerning the CRE sector. Companies generally are beginning to reappraise the amount of space they need, and the basis on which they take that space. Furthermore, a prolonged spell of working from home might start chief executives and finance directors thinking about whether they really need huge offices on 10-year leases with 50% of the desks empty (especially on Fridays).

Without question, it is our view that when things begin to return to normality, many companies will re-evaluate how they utilise workspace—and undoubtedly the beneficiary of that will be the flex sector. Naturally, we believe there will be some office downsizing as companies begin to recover from a downturn in revenue and that for many occupiers stuck in long leases this may take the form of sub-letting activity, or indeed companies renting out space to startups within their own offices.

We also strongly believe this will accelerate the number of traditional office landlords embracing flex solutions, either by partnering with an operator or by launching their own brand/solution. 7% of London’s total office stock is already flex space, and we can see that growing to double figures very quickly as a result of this new paradigm. The 30% flex space by 2030 prediction by the industry that felt quite bold a few months ago looks like it might even happen faster.

For now, we are still helping companies secure new offices on a daily basis, although without question many of the larger companies are putting those decisions on hold whilst they focus on protecting their business. In the meantime, we are endeavouring to support businesses of all sizes and our landlord partners wherever we can—through everything from organising virtual viewings and advising on the best office space strategy, to providing resources and webinars to help businesses make remote working the best it can possibly be at this time of great uncertainty.