The COVID-19 pandemic continues to disrupt public health and economic activities across the globe. While the full effects of the virus remain to be seen, we need to be prepared for what is a challenging time. Relationships between tenants and landlords have been disrupted as millions of people shelter in place, thousands of businesses close their doors, and the Canadian economy faces its biggest challenge since the 2007-2009 Great Recession.
I’ve gathered some resources to help you navigate potential issues among commercial tenants, landlords, and lenders. Market forecast contributions are from CBRE Media Relations and Avison Young public reports.
How Landlords Can Respond
As retail outlets across the country try to recover, tenants have been approaching landlords about negotiating rents. When a business closes suddenly, even if it’s temporarily, the tenant cannot produce rent, meaning a landlord may have difficulty paying a mortgage (if there is one). There are no winners in this situation. Here are some viable alternatives to mitigate this issue:
- Rent Reduction. The landlord can reduce the tenant’s rent for a portion or all of the term left on the lease. The usual forms of rent reduction are to reduce the base rent, operating expenses, or both. In regard to retail, it is possible to convert base rent to percentage rent.
- Rent Deferral. In this case, the landlord can defer a portion of the tenant’s rent but would require them to repay the rent deferred at a later time, either in a lump sum or by increasing subsequent payments. A variation of rent deferral could be to cap or set a base year to operating expenses for a short or extended period of time.
- Rent Abatement. If a tenant is significantly past due on rent payments, a landlord may agree to forgive a certain amount of the past due rent if the tenant remains current thereafter.
- Loan Conversion. Rather than abating past due rent, a landlord may agree to convert the past due rent into a loan payable over time. The tenant would, however, continue to pay the current rent. The loan is then evidenced by a promissory note that is cross-defaulted with the lease.
- Application of Deposit. If the landlord holds a deposit, this amount could be credited against the tenant’s current obligations.
- Subletting. Bringing in a new tenant (for part of or all of the rented space) could reduce or eliminate the rent obligations while replacing revenue for the landlord.
How Tenants Can Respond
- Review your lease to see if your rent is simply base rent or it includes pass-through expenses. How much are these expenses and are they set to increase?
- When does your lease end? What renewal options are available?
- What constitutes a default of the lease? What tools are available to the landlord in such a case (penalties, eviction, interest, etc.)?
- Does your landlord hold a security deposit? If so, how much is it?
- Is there a guarantor obligated to pay your short fall? Have you informed your guarantor of your situation?
- Review operating covenants and co-tenancy.
- Speak to your insurance agent to see what coverages are maintained by each party. Know your options to file a claim under existing insurance.
- Does the lease include force majeure, excusing a party’s performance due to outside circumstances?
- Explore governmental relief programs, which may be popping up quickly, for tax relief, access to loans, relaxed restrictions/regulations, etc.
- Consider consulting a lawyer to know your options in limiting your financial obligations.
- Based on our current financial position, understand what concessions you would need from your landlord in both best- and worst-case scenarios related to COVID-19.
- Contact your landlord and specifically outline how your business is being impacted by the COVID-19 pandemic. Arrange a meeting and be prepared with data to have an open conversation to identify a solution or combination of solutions.
Examining 2022 Challenges Faced by Different Market Sectors
- The Greater Toronto Area (GTA) industrial market remains resilient. In the past two years, industrial has been the sweetheart asset class – strengthened by limited supply and relentless demand that has seemed endless. But flattening growth may be on the horizon as some of the largest users begin to reach near-peak growth. With 60 million square feet (msf) in the development pipeline for the next three years, rising availability will likely provide more space options to a broader spectrum of industrial tenants compared with today’s constrained supply environment.
- Businesses will carry more “safety stock” inventory to guard against supply disruptions. The shift away from the “just-in-time” model to a “just-in-case” framework will increase demand for warehouse space.
- Investment in automation and robotics technology will increase in new builds and these investments will help occupiers meet operational and environmental-efficiency targets.
- The Greater Toronto Area (GTA) office market continued its recovery during the fourth quarter of 2021, as tour activity remained lively and availability of sublease space declined. Many companies’ return-to-office plans have been pushed back once again by the arrival of the Omicron variant in December, but there is a sense that momentum continues to build as firms prepare for the future.
- Office market conditions will strengthen in 2022 as the positive momentum first seen in the fourth quarter 2021 accelerates. Office workers will return to in-person work allowing employers to test new workplace strategies that enable hybrid work.
- U.S.-based tech occupiers will resume their Canadian expansion plans, bolstering demand for high-end office space and increasing the competition for tech talent. Top beneficiary markets in 2022 will include Montreal, Edmonton and Waterloo Region among others.
- The Greater Toronto Area multi-residential investment market continued to display strong fundamentals in the fourth quarter of 2021 and exhibited the reasons it remains a sought-after asset class for both institutional and private investors. Market fundamentals have strengthened over multiple quarters, increasing stakeholders’ optimism, and pushing cap rates down. Growth in the sector is only constrained by the lack of assets available for sale.
- Demand for rental housing will continue to recover and accelerate in some markets in 2022; the greatest beneficiaries of this growth in demand will be urban cores.
- Multifamily vacancy will decrease over the next year due to insufficient new supply and growing demand from tenants.
- Retailers and shopping centres will focus on experiences, placing greater emphasis on physical locations in a bid to recapture market share.
- Retailers will continue to explore new business models and concepts, such as a well-known pharmacy chain partnering with a provider of family and internal medicine services.
- Environment, Social and Governance (ESG) considerations will be top of mind for real estate investors in 2022.
- The rise of ESG-focused office occupiers will see these projects receive increased attention in the market. These properties will offer the authenticity and aesthetics of brick-and-beam buildings combined with the modern infrastructure of new builds.
- While many investors are still unclear on the best ways to identify and adopt ESG best practices, the majority of the industry, certainly at the institutional level, have already begun prioritizing ESG across their portfolios.
“For commercial real estate, 2022 will be the year that ESG transitions from the what to the how, or from the ambition to the execution,” says CBRE’s Vice Chairman Paul Morassuti. “The ambition is a net zero world by 2050 and the execution is about integrating ESG factors with financial factors into the investment process.”