The impact of coronavirus on commercial real estate Translation of an article that appeared in Finance, Slovenia’s daily financial newspaper, on Tuesday 31th March 2020

By Jacqueline Stuart

This is not an article I ever expected to write. I am now on my 16th day of lockdown in Trieste. In Italy nobody is permitted to leave their home, except to buy food, go to the pharmacy or walk their dog. It is a criminal offence to contravene the law, punishable by prison or fines. I have gone from being a cross-border worker living my life in two countries, to a different reality.

It is extraordinary that a tiny thing like a virus can bankrupt the world, and bring it to a complete standstill. A virus has no brain, no body, no consciousness. It cannot even divide its own cells. It is just a little bit of nucleic acid enclosed in a protein coat. It is clear to me that mankind’s belief that humans are superior to all else on earth has been shattered.

When considering the effects of coronavirus on the commercial real estate market, it is hard to know where to start. We have to consider market dynamics from a completely different angle. There are no tangible effects so far, because most markets are frozen. The impact will be seen when restrictions are lifted and we try to return to normal. 

The obvious place to begin to  analyse the potential effects is to compare the pandemic with the global financial crisis; however there are important differences. Following the crash in 2008, the supply of credit dried up. But business went on to some extent in most sectors. Many countries in the world are now on lockdown, and most others will follow.  There are only a few winners in this crisis. Manufacturers of medical equipment, tech companies providing software that facilitates remote working, food producers and supermarkets, and home entertainment providers.  Any pharmaceutical company that could provide a vaccine quick enough, or effective treatment, could be a big winner. Other than that, this virus will leave a trail of devastation unlike anything we have seen before. The one thing that all commercial real estate has in common is the requirement for successful companies to occupy it. What governments do next will be crucial. Many governments, including that in Slovenia, have quickly introduced emergency measures to keep companies in business.

The global financial crisis taught us that it is disruptive, time consuming, and expensive to let companies go bankrupt, and have the state shoulder the responsibility of dealing with the fallout and paying unemployment benefit to people unable to find new jobs. 12 years later, Slovenia is still dealing with the consequences from 2008, with countless assets still unsold by the state owned bad bank.

Borders will have to stay closed for many months due to the different strategies adopted by different governments, and the different stages of the pandemic across the world. Is it possible that any airline could survive months of planes being grounded? Alitalia was nationalised a few days ago, but few countries nowadays have state owned airlines. 

Mankind will get over coronavirus. Countries that introduced early lockdown measures will get over it sooner.  Governments that delay taking the right measures, in what they believe are the interests of the economy, will cause countless deaths of people who could otherwise have been saved, and long term damage to citizens and businesses, as social distancing has to be extended. Italy introduced the lockdown too late, and is now paying the price. But Italy was the first western democracy to do so, against the common belief that citizens would not comply. For that the world owes Italy a debt. 

It is likely that the market will be impacted by a reduced volume of transactions, and lower prices.  Even if the uncertainty lasts for a short time, buyers and investors will be more prudent, and will delay non-essential investments. Increased unemployment will have an impact on the residential market.

The risk premium for real estate investments is expected to increase, and will take into account liquidity problems of occupiers and increased vacancy, in the short term.

The big advantage that the pandemic has over the global financial crisis is that once it is over, there is less to impede a quick recovery.  Everyone will be keen to get back up and running. There will be no need for banks to spend years writing down overvalued assets before being able to return liquidity to the market. We can expect governments to do everything possible to stimulate the economy. There is nobody to blame here, just a virus.

Let’s look at each asset class in turn:

Hotels and hospitality

During the global financial crisis hotels saw one and a half years of occupancy decline, it then took three and a half years to get back to occupancy levels pre-crisis.

Hotels in Slovenia will need support from the government to survive. Because of high fixed costs, most hotels can survive for only a few months, or even weeks, without revenue.

We cannot expect that the hotel business will get back to normal any time soon. Different countries are at different stages of the epidemic. Italy was the first European country to be hit, however it might not be the first country to come out the other side, because the number of cases is so high. Countries like Slovenia, with far fewer cases, and the benefit of knowledge that Italy did not have back in January, might be in a better position to recover sooner. However that will depend on curtailing international travel, particularly to and from countries that are only just seeing their first infections and will not see the peak for some time. I predict that none of us will be travelling long haul any time soon. One advantage that the Slovenian tourism market has is that most guests arrive by car from neighbouring countries. Assuming that lockdown is lifted in those countries at a similar time, this could benefit Slovenia, particularly this summer.

Retail

I wrote last month about the impact of eCommerce on retail real estate. Retailers that have not been able to combine clicks and bricks have suffered and many have gone out of business. Now they have to deal with closed stores, a huge number of families suffering from reduced earnings, and poor consumer sentiment. Very few consumers will be buying anything other than basic necessities for some time. Fashion brands in particular will suffer because they will have to scrap most of their spring inventory.

Office

Regardless of what help the government provides, some businesses will fail during this crisis, and we can expect increased availability of office space. There was a severe shortage of Class A office space in Ljubljana before coronavirus began, and it had shifted from a tenant to landlord market. Occupiers in Class A are less likely to close down, being mainly global companies, but some may need to downsize. Martin Sorrell, British Media magnate, predicts that the Digital revolution will be accelerated by Coronavirus, both at an eCommerce level and a business level. Everyone will have to communicate over the internet, and many will probably like it. Office occupiers might decide that having employees work from home suits them better than paying for large offices.

Industrial

Industrial will suffer short term as production is halted and inventory drops. But longer term it should benefit as the digital revolution is accelerated.

What can you as a Landlord or Tenant do?

Law firm Wolf Theiss has published a paper on Coronavirus and the obligation to continue to pay rent. There is no specific provision in law in Slovenia that allows for a reduction of rent in case of an epidemic. They conclude that general principles of the law on contracts apply. The law states that if the performance of obligations (i.e. to pay rent) becomes impossible or partially impossible for one party to a contract because of a development for which neither party was responsible, then a party may withdraw from the agreement, or demand a proportionate reduction of its obligations (i.e a rent reduction). There are other parts of the law that might also be applied, however there is no precedent and any rent reduction might have to be agreed in a court of law.

As always, the key to resolving rent issues is good communication between Landlord and Tenant. Many Landlords have bank finance and need to pay mortgages. It is in all Landlords’ interests to help their tenants as much as possible, to ensure they are able to stay in business, and that they can return to paying full rent once the restrictions are lifted. The interests of Landlords and Tenants are inextricably entwined.

Most lenders will do what they can to provide payment holidays, thereby allowing Landlords to provide rent reductions to tenants. All tenants need to be considered individually. Some business sectors can expect zero revenue until the restrictions are lifted, whilst a lucky few are working overtime due to the pandemic.

Our advice to Landlords is to engage with your Tenants, make it clear that you want to listen to their issues and that you will do what you can to help. Advice to Tenants is the same, engage with your Landlord, set out your position transparently and make it clear how you expect your Landlord to help.

The future

The Editor of Chinese Vogue reported that after six weeks of draconian lock-down, life in Beijing is gradually beginning to return to normal: shops are open, with a smattering of customers, restaurants and bars are operating, albeit with a rule that specifies no more than three people per table, carefully distanced from each other.

In short, there is a semblance of the big-city vibe once more, but also a feeling that the very fabric of life has changed. She reports that  ‘in China, we feel we are coming out of the nightmare, but gradually and hesitantly; there is no celebratory mood, just one of relief and gratitude that we are alive and healthy.’

I believe that coronavirus will change the world in the same way that other momentous events such as 9/11 changed it. A scientist interviewed on Sky news pointed out that this disease has highlighted that every human being on this planet is connected, and that we will need a global response to get over it. I believe everyone who lives through this will have a different perspective on the world when it is over. Wealth and privilege provide no protection from coronavirus. Private hospitals have been taken over by the state the world over. The developing world will need help from the developed world to cope with the disease, until they are safe, nobody is safe.

The Black Death devastated society in the middle of the 14th century. It led to great socio-economic, cultural and religious changes. After the initial horrors of the plague, society staged a spectacular recovery. Europe became richer than before. The Black Death marked an end of an era, its impact was profound, and it resulted in wide-ranging social, economic, cultural and religious changes. These changes led to the emergence of the Renaissance, one of the greatest epochs for art, architecture, and literature in human history. Before this crisis started, there was already a groundswell of public opinion that the wealth inequality in the world is unacceptable. As well as anger at global tech companies that have come up with elaborate schemes to avoid tax. Governments’ tolerance could change radically, as they struggle to ensure every family has enough to survive.

Unexpected side effects of the pandemic have been reported – the water flowing through the canals of Venice is clear for the first time in forever. The fish are visible, the swans are back. A dolphin was even seen in Trieste a few days ago. Skies are free of pollution in China. It occurred to me that there is nothing that any environmental organisation could have done that is as effective as this virus in helping the environment. As terrible as it is, is it possible that this could heal the earth?

Jacqueline Stuart is a Director of S-Invest d.o.o.