State shutdowns, stay-at-home orders and public health restrictions have thrown a massive monkey wrench in 2020’s economy. The government swooped in with a massive bailout, and it seemed for just a minute that if businesses could just hang on through the shutdowns, then we’d all make it through. Real estate and tax attorneys David, Nathan, and Richard at Buckingham Law in Ohio are used to working with distressed properties, so they’ve got some really interesting insights on the unprecedented shift we’ve seen in real estate this year.
For now, things are holding steady, but there are some potential problems that real estate investors need to keep their eye on. Many tenants deferred rent, but they’ll have to come up with the balance eventually. For many who were in the process of purchasing new properties, they’ve been able to negotiate down purchase prices, but rent collections in commercial real estate are a huge concern. And of course, the PPP loans that many have taken will have to be reckoned with by the end of the year.
The Problem with Deferring Rent
When shutdowns occurred, commercial tenants who couldn’t open for business had an immediate cash flow problem. If they quickly opened up a line of communication with their landlords and deferred their rent, then everyone involved might’ve felt that they’d solved their immediate problem and could take a deep breath.
Nathan already works in the distressed market, and he’s seeing that a lot of the people requesting PPP funding are business owners who were already distressed. One of the potential problems with deferring rent is that tenants or landlords may only get further behind because they weren’t in a strong position to begin with. Keeping those lines of communication open between landlords and tenants is going to help prevent any surprises if a tenant’s business completely collapses. In turn, landlords should communicate with their banks about any problems they might have paying on their mortgages. The best thing to do is simply be proactive and practical about the entire situation, and take each situation on a case-by-case basis.
One word of caution from David is that landlords should not always take everything a tenant says at face value. Some of the major public companies are asking for rent relief from landlords when they have access to funding or credit lines. Verifying their requests with financial documents is a simple way to protect your commercial real estate portfolio
Cracks in Commercial Real Estate
Rent collections in some areas are still being propped up by state and federal unemployment checks, but that won’t last forever. I’m sure some of you have heard the same horror stories about 20-25% rent collection in some areas. A diversified tenant base in multifamily will help you get through a downturn like that, but what about strip malls, office buildings, movie theaters and medical centers?
This is one of the parts of the pandemic that we’re going to have to wait and see on. How soon will people feel comfortable going back to restaurants and gyms? When will shopping become a casual activity again? If people don’t feel safe or comfortable, then regardless of whether government restrictions are lifted, sales are going to go down in physical stores. And that’s going to put another nail in commercial real estate. We will definitely be keeping a close eye on how this plays out over the next 18 months.
Writing Off PPP Loans
Businesses who took PPP loans have been able to keep themselves afloat throughout COVID, but there are some important points that business owners need to pay attention to. One of the great things under the PPP loan is that rent is going to be one of those items that are forgiven. But the IRS doesn’t want anyone double-dipping, so the expenses that are forgiven under the loan cannot be deducted.
A quick example would look something like this: A business has a $500,000 PPP loan and $400,000 of that is used for forgivable expenses like payroll, mortgages, or utilities. Previously they could have written off that $400,000 for business expenses, but because they took the PPP loan, they can’t. This ends up being a net zero situation because while they can’t write off the expense, it’ll be forgiven. Plus, a business gets the liquidity it needs to pay its employees.
Some businesses will wonder if it’s worth it to take the PPP loan to pay employees when they can’t even be open for business. This will have to be a personal decision for every business owner to decide if he wants to continue paying his employees money that’ll be forgiven, or just close up shop because the business can’t stay open. For what it’s worth, Richard says he’s never seen a bad deal when it was bad to take the PPP loan.
Some industries have been hit particularly hard by the pandemic, including bars, restaurants, movie theaters, and some office buildings. We’ve definitely seen a lot of businesses that were already on the edge go completely under. But there are some promising signs in commercial real estate. As liquidity has dried up, buyers who don’t have private money are getting shut out of deals. We’ve been able to go back on properties under contract and retrade the deal. We have a 265-unit deal in Northeast Ohio that we were able to get a substantial discount on because we were in a strong negotiating position.