We all know that rents just go up, but do they actually? In a normal well working economy, they often do. In speculation, there may be a new normal in market rents coming. How drastic of a change will it be? It may all depend on what businesses can afford, or landlords may be in trouble financing their properties.
So, what changes? Well, the value of real estate might, and it will bring a lot of implications with it. There are many factors that make up real estate value and it is complicated. The major valuation tool in commercial real estate is income generation. If a landlord gets great net profits from rents, the property is worth more through a market capitalization factor. If they have desirable tenants paying good rents, the better the net profits and the more value generated. But what happens if these tenants can no longer afford these high rents at these expensive buildings?
Many businesses are shut down during this quarantine and hurting bottom lines and cash flows all in the name of social protocol or government intervention. Every choice comes with some good and bad, and it’s a delicate balance. You don’t want to close but you are unsure if your business can weather this storm, and it might not even be your choice! If tenants are so disrupted by the pandemic mitigation efforts and have to close down and move out and the landlord can’t replace them at high rents, the value of the property will start to slide, tenant default by default.
They must find a market equilibrium, in this case a market rent that works for the landlord and tenant, as they need each other to run their business. Obviously, this would mean lowering the average market rent to retain tenants and some profitability. This would lower the value of the building and depending on how much of the landlord’s mortgage is outstanding; be over leveraged in a high interest / deflationary time. There must be some reconciliatory efforts on both party’s behalf. The damage of businesses’ bottom lines and cash flow, because of not being open to the public in this unprecedented time, can’t all be put on with the tenant or landlord exclusively. Good negotiations will help both parties get the best outcome, and it’s best to start with the knowledge needed to start them off right.
What can we expect as a new normal, and what role with Force Majeure clauses in your lease play in sorting it all out? That is up in the air, but we can try and start to prepare ourselves for what that may look like. In times of impending recessions, it may depend on what the government does to mitigate current issues, the mood of the business climate and culture, interest rates, but most importantly the unemployment rate and the free moving of people in society. Being proactive and looking out for your business NOW by securing your leased space at a tolerable rent for the longest period possible is in your best interest.
