These Are The 6 Biggest Lingering Covid Issues Affecting Real Estate
A year after the coronavirus pandemic first ground commercial real estate transactions to a complete halt, deal-making activity has resumed with vigor. But both landlords and tenants are still navigating the lingering effects of the pandemic across several fronts, including finances, leases, development and business operations.
Moody Law Group founder John Moody Jr., who specializes in commercial real estate law, told Bisnow that lease restructuring, foreclosures, deed restrictions, bankruptcies, reopening challenges and permitting are among the most pressing hurdles for his clients navigating a world where the pandemic’s hold is easing.
Inquiries about these issues are coming in to his office every day, though Moody said there’s no singular one that stands out as the most difficult or pressing on a daily basis.
“I'm dealing with a little of these every day, but not one of them is really taking over my practice,” Moody said.
Below are six of the biggest pandemic-related challenges that commercial real estate landlords and tenants in Houston are still dealing with, according to Moody.
Lease restructuring and defaults
The pandemic spurred a wave of lease restructuring and defaults, according to Moody. In the last 12 months, he has negotiated several lease buy-outs for office tenants. Some can no longer afford the space, while others have simply decided they no longer need it.
“I'm doing a ton of people buying out of their office leases, people downsizing other office leases, tenant defaults. I've negotiated settlements on a bunch of leases that are in default. There’s still a lot of lease issues out there,” Moody said.
On the retail side, another ongoing headache is co-tenancy, a clause that allows tenants to reduce their rent if an anchor tenant or other key tenants leave the property. Though co-tenancy is always challenging, the issue has been amplified by the pandemic and is unlikely to subside any time soon.
According to Texas state law, foreclosure auctions can only happen on the first Tuesday of every month. However, Harris County Judge Lina Hidalgo shut down the auctions last April by blocking all occupancy of the Bayou City Event Center, where the auctions are usually held, on that single day each month.
Moody said that Harris County is the only county in Texas where foreclosures have been blocked throughout the entire pandemic, which has created major legal hurdles for lenders to enforce their loans.
“The normal process of your lenders being able to put their borrowers in default and being able to foreclose and take the property back has effectively been halted,” Moody said.
Moody has worked with clients to craft demand letters and place loans in default, but those situations have not been able to move forward. He noted that once foreclosures are permitted to resume, the huge backlog could cause some temporary challenges in managing the volume.
“We have posted for foreclosure a number of times during this shutdown for clients. We just haven't actually been able to foreclose. It's just been a lot of these kinds of threatening letters and forms saying we're going to foreclose, but we really haven't been able to,” Moody said.
Many retail properties have extensive deed restrictions and prohibited uses, making it difficult to introduce new concepts or experiential retail. In the past, those requirements were often connected to concerns over available parking.
However, the pandemic has led to an increase in the number of vacancies in shopping centers in the Houston area, and Moody said he is seeing more landlords trying to amend those restrictions to try and fill the vacancies.
“What folks are trying to do to fill those vacancies is, they're trying to create more destination and experiential types of projects, where you're getting folks and their families out to the project. So you're seeing a lot of more entertainment-oriented type uses,” Moody said.
In order to repurpose retail centers and attract new tenants, landlords are often required to amend substantial legal documents with anchor tenants, adjacent property owners and existing retail leases to permit new uses at the center.
“I think the pandemic has accelerated some of the change that's needed for certain retail projects, certainly for malls,” Moody added.
Bankruptcies have been widespread throughout the pandemic, with major retailers like JCPenney, Neiman Marcus and Brooks Brothers all filing for Chapter 11 bankruptcy protection. By filing for bankruptcy, those tenants are able to terminate leases at underperforming stores and reduce their overhead and footprints.
Moody said that it has pushed a lot more retail space back on the market in a speedy fashion, because the bankruptcy process can happen quickly. That square footage can return to the market as quickly as 90 days.
As a lawyer who usually handles the landlord side of the business, Moody said his clients are getting notices of bankruptcies from lots of different tenants. Typically, those tenants will either hire a real estate consultant or have an in-house real estate team to reach out to the landlord and try to restructure the leases.
“They typically do it on all their leases, even the ones they want to keep. They'll say, ‘look, for this period of time, we need our rent reduced, or we need our rent abated, or we need to change our lease term,’” Moody said.
Those negotiations tend to happen at a much faster pace than usual, he added.
“There's usually sort of these fast-paced negotiations with these tenants while they're in bankruptcy, and I've had to do a lot of that.”
Capacity and confrontations
When Texas Gov. Greg Abbot lifted the statewide requirement for face coverings and occupancy limitations, he gave business owners the ability to determine what capacity they wanted to operate at and if they still wanted to enforce masks.
Moody said that while the move has helped many businesses reopen fully, it has placed owners in a position where they have to balance safety with their customers’ demands.
“I've had a lot of clients call me, certainly the tenants and restaurant operators and retail operators, just asking what are they obligated to do. And there's this balance between taking care of your employees and also taking care of your customers,” Moody said.
Feedback from restaurateurs and retailers has indicated that many preferred having the statewide mask mandate, because it didn’t place the burden on them to tell customers what to do. The risk of physical confrontations has also escalated, making it a difficult issue for business operators to navigate.
“Landlords, tenants and business owners are all having to deal with this and decide how best to operate their real estate and businesses,” Moody said.
In the earlier days of the pandemic, the process of getting a permit from the city of Houston or Harris County slowed to a crawl. Remote work made it harder for officials to review and process documentation, and in-person meetings and submissions began to move online.
Moody said he has heard anecdotally that things have improved, but permitting can still be a long, somewhat unpredictable process. And ultimately, delayed permits lead to financial penalties for developers.
“From a developer standpoint, if you're doing a build-to-suit deal for a tenant, they're usually on a time frame where if you miss your deadline, there's penalties,” Moody said.
He noted that lawyers have been careful during the pandemic to build more exceptions into contracts between clients and tenants, because in many cases, the permit delays may not be the developer’s fault.
“If they've submitted their plans, and they're doing everything they can to get the permit, and they just can't get it done because of delays of the city, then we try to not have penalties for that,” Moody said.