De-risking the real estate sector following the Covid-19 pandemic

The disruption caused by the Covid-19 pandemic has accelerated digitisation in the real estate sector while exposing weak spots in portfolios that need to be addressed to make the sector more resilient ahead of potential future crises. The impact the pandemic had on businesses in retail and hospitality has directly reflected on real estate owners. In many cases, tenants applied for rent discounts, suspension or waiver of rent due to loss of income. 

Not all tenants fared the same: While data centres and warehouses thrived, many businesses in retail had to quickly adapt and digitise the business. Companies in hotel & leisure were largely forced to stop operating during the pandemic. While the hardest hit segments are likely to recover somewhat as the vaccine rollout progresses and social distancing rules are relaxed, some general trends are likely to prevail.

Adjusting the portfolio

Adjusting the real estate portfolio to reflect market changes and focus on tenants that have performed well during the pandemic will also make it more robust for potential future crises. 

  • Retail

Lockdown and social distancing measures resulted in empty stores and shopping centres and created an e-commerce boom, but many businesses adapted quickly to offer "click&collect,” curbside and home delivery, showing great business continuity management. The online transition in the retail world is likely to continue transforming the high street. Logistics should therefore remain one of the most buoyant segments in real estate.

  • Hospitality

Along with retail, the hospitality segment has been one of the hardest hit by the coronavirus crisis but it might recover swiftly as the virus outbreak gets under control. The impact on business travel as video conferencing proves sufficient in many cases as well as near-shoring of supply chains may have a permanent effect on some hospitality areas. Leisure travel may also shift to local destinations for longer as consumers fear travelling overseas. 

  • Office space

Offices may undergo significant transformation. Increasing home-working may translate into a reduction of required office space, but high-quality space may be needed, with smarter fit-outs and enhanced communication technology. At the same time, social distancing may be required for longer in offices even after the inoculation of the majority of the population. This would mean that each employee will need more space than before the crisis, reversing the multiyear trend toward densification and open-plan layouts. 

  • General trends

Assets that have greater human density seem to have lost most in value during the crisis, according to a McKinsey report. This includes healthcare facilities, regional malls, lodging, and student housing. Self-storage facilities, industrial facilities, and data centres have faced less-severe declines.

While before the crisis companies that had little business online may have appeared more attractive to real estate owners because of a lower perceived risk that they would move further online, this view might have shifted somewhat following the pandemic. Tenants that were able to operate online during the pandemic were more resilient, managing to continue generating revenues and therefore paying rent. 

The residential segment has proved remarkably resilient in the current context. Perhaps the fear of viral outbreaks like COVID-19 may prompt older tenants to stay in their current homes longer. Nevertheless, it is also possible that senior-living facilities could prove to be best able to handle viral outbreaks, accelerating demand.

Digitising real estate services 

Over the past several years, industry leaders have been diversifying sources of revenue, pursuing digital strategies, and focusing on tenant experience. Physical distancing and the lockdown have magnified the importance of digitization also within real estate. Players that have invested in digital sales and leasing processes using virtual showings, augmented and virtual reality, as well as omnichannel, targeted, and tailored sales were at an advantage.

The COVID-19 crisis has accelerated the need for those strategic changes—and highlighted that those that haven’t yet made such investments will probably need to catch up quickly. For example, while relatively few real estate companies were actively developing or pursuing digital and advanced analytics strategies before the pandemic, such strategies can help with tenant attraction and churn, commercial lease negotiations, asset valuation, and improved tenant experience and operations. 

Digital-first products and experiences will be a differentiating factor for operators, including telehealth, on-demand delivery and concierge services, virtual communities, contactless access for residents, guests, and maintenance staff.  Digital investments have paid off during the pandemic as they allowed real estate companies to continue activities during the crisis while paving the way for the creation of new revenue streams.

Risk Management Plan

To help reduce the risk further ahead of future pandemics, real estate owners should define a route to safeguard business, facilitate all stakeholders and keep focused on the long-term ambitions in congruence with the general business continuity planning. This may include rent suspensions helping tenants to survive and strong account management orientation to engage tenants. The need to meaningfully engage with customers and employees on health and safety in physical spaces rose significantly during the crisis. The plan should also include options to reduce the cost base and operating expenses. 

In times of crisis, businesses must quickly identify the key internal and external players that will be impacted and require critical attention as well as their specific needs and/or interests and build their crisis responses around them.  During this current crisis, real estate companies have started to build information and intelligence monitoring capabilities to prepare for and take necessary decisions. This has included agreeing on scenarios and triggers that, when met, result in particular organizational action such as the reopening of offices. Organizations should not only maintain information and monitoring capabilities built during the crisis but also expand it to include other risk types identified during the crisis that could create another significant disruption down the line.

While enhancing an old crisis plan or developing a new one will take work (and cost money) upfront, it is a process that is likely to pay off in the long run. 

Companies are concerned about the implications of opening up and being held responsible for employees/visitors getting sick. At the same time there is the risk that keeping the business closed for too long may raise issues from a directors’ and officers’ (D&O) liability/shareholder perspective. There are regulations to comply with for workers’ compensation and general liability and being a “good employer” from a corporate social responsibility (CSR) perspective may help raising trust in the company.

Insurance protection

Since COVID-19 certain carriers have responded with risk transfer solutions for specific industries focussed on the next epidemic/pandemic. 

In addition to risk mitigation measures, real estate companies can now look into covering remaining risks against future pandemics via tailored insurance policies. Any protection will exclude Covid-19 but could indemnify rent defaults or/and deferral or abatement or match new lease clauses that allow for rent reductions in the event of another pandemic. For this purpose, companies will need to disclose their recent experience, issues around rent and how they plan on handling rental issues going forward. An insurer will likely want clarity in the contractual language in place between the real estate owner and the tenants with regard to the responsibility for paying rent following a pandemic. Insurers will also want to hear about the company’s business continuity plan in place.

Any insurance negotiation will need to involve an agreement on the appropriate trigger for the insurance policy. This could be a local lockdown or travel bans in other countries that may prevent tourists from visiting.

Real estate and retail clients are currently focusing on covering extra expenses in a future pandemic as well as the uncertainty of future income levels. Real estate clients are particularly keen on lease clauses that give defined and limited rent abatements which they can then match to the capacity available for the outstanding risk.  

Limited capacity in the market may make it challenging to achieve required limits to protect the company against future pandemics. Insurers are currently requiring a minimum limit of $5M which would cost an insurance buyer between $100K and $500K in premium. The same premium/limit ratio range can be applied for higher limits of up to $50M and perhaps more capacity on a case by case basis. 

One alternative could be to create a captive solution or to add the risk to an existing one. Furthermore, a company captive can be used alongside a market carrier where the two can complement each other in terms of combined capacity and technical expertise to price and structure a robust, compliant solution. Having the necessary information readily available can speed up the underwriting process. 

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