As a unique and devastating force majeure, the COVID-19 pandemic tested how well we could navigate what seemed like never-ending economic challenges. It was, perhaps still is, a game of The Floor is Lava. When you must jump high or burn your feet, your best chance for success, in real estate or otherwise, comes from embracing the challenge and moving toward it calmly and confidently.
Our success always depends on how we shape our relationships with stakeholders. But now, mundane actions and relationships–things that we often take for granted or do infrequently because of how smoothly they normally operate–moved to the forefront. The pandemic forced us to think about ourselves as the hub of a wheel. To keep it moving, our work was ensuring that every spoke in the wheel could play its role well. The lessons bring into high relief how we can do our jobs better during normal times as well.
Relationships and Information at the Forefront
Regardless of disagreements regarding lockdowns, we had to face the reality that companies were furloughing, laying off, or letting workers go, small businesses were temporarily or permanently closing, and large numbers of people were unemployed. Economic activity didn’t just slow. It ground to a halt during April and May 2020.
We could expect and ask retail tenants and residents to pay monthly rent, but businesses and families suddenly had no revenue or income. They knew that very quickly their reserves and savings would disappear. Our situation was the same. Reality was not supporting our underwriting models, and we needed information to develop effective plans.
At the time, Mark Hansen, our director of operations, told me, “You can’t ask an individual whether they lost their job.” A business tenant might not be forthcoming if you ask whether they are in danger of shutting down operations. But in both cases, you can draw inferences from macro data.
Our go-to resource is the National Apartment Association. They have aggregate big data about collections, for example, that we could monitor to stay informed about what was happening in our markets. Combined with data on unemployment and economic activity, we could infer what percentage of the population was struggling and why. This would tell us what business and residential tenants could and could not do.
Although it seems counterintuitive, the government ban on evictions helped us gather information. Once individuals and families trusted that they would not be evicted if they could not pay rent, they began to talk about their situation. The nature of COVID-19, which sometimes led to severe illness and death, gave us another incentive to do whatever was possible to keep residents in place. It was clear as well that we were less likely to find new residents. No one was moving around.
In the normal course of real estate investing, most owners like American Ventures® rely on third-party professional management companies to manage day-to-day activities. We don’t usually conduct daily reviews of resident-level information. Instead, our property management company gathers information and reports on it in aggregate once a week and once a month.
Safe housing is a basic necessity, even more so during a pandemic. To combat the COVID-19 contagion, property management companies had to halt normal, day-to-day operations. In the resulting uncertainty, we needed to know about residents on a more personal level to make and implements effective decisions.
Our situation with retail tenants was similar. We might want to keep a retail tenant, but if their business closed there was not much we could do. The solution in both cases was to partner with businesses and residents and find ways to help them stay in place.
Our biggest footprint is in multifamily properties, largely because this asset class performs well compared to other real asset classes in times of economic uncertainty or economic boom. However, we own one mixed-use apartment complex with retail space in downtown Waco, a block away from Magnolia Silos.
We’ll look at a case based on one of our retail tenants at this location to illustrate how we managed the challenges the pandemic brought. Regardless of the asset class, the key to success is having enough information to make good decisions.
A Case Study on Preserving the Investment
Some facts are so obvious that we don’t usually think about them. For example, both retail businesses and property owners know that owners must pay utility companies, lenders, tax escrow accounts, and insurance. Retail businesses know that operating rent-free is not an option. Owners know similar facts about retail business tenants. Even with limited revenue, they need to pay employees, suppliers, and so on, to stay in business. These facts drive owners and businesses to develop a mutual understanding that each must give during negotiations.
Negotiating when there is little margin for error is stressful. In the time of COVID-19 lockdowns, the stakes demanding cooperation were so high that all parties knew they had to play nice. Competing over who was getting the best of a bargain was not going to work.
In this case, our retail tenant was a home décor store that sold stylish and unique home furnishings. They had been open for six months in a temporary space, rent-free, while we built a retail space tailored to their needs. They moved into this new space just before the pandemic hit. Although they were generating income and a stable revenue stream, they were still operating on a razor-thin margin. By April, the business was generating no income and could not pay both the rent in May and its operating expenses, like employee salaries and suppliers.
We examined data about what was going on in our larger market—the macro data at city, county, and state levels. We also factored in information about how local universities and government were handling the economics of the pandemic. This information told us that other retail businesses would not be coming to rent this space. Consequently, we needed to create a deal that would preserve our investment return assumptions for our investors, lenders, and American Ventures.
To cover the May rent, we worked together and created a plan of escalating rent payments for June. By July, the business would be back to a normal rent payment. At the time we worked out the deal, paying June rent plus May rent spread over four weeks looked doable.
But the economy was still shut down in June, and the plan crashed into reality. In the end, we renegotiated two or three plans over the summer before we got to a point where the retail tenant could make the plan work.
The Case of Residential Commercial Real Estate
Retail businesses understand the need to team up better than residents. Although a business might not reveal all their financial details, they will share enough to create a workable plan. Resident-owner relationships are often adversarial. Regardless of the nature of the relationship, we knew the situation was similar. Residential tenants were not migrating, and the same questions applied. Are people paying the rent? Can they?
To get some insight into what residents were capable of doing, we again looked at big-picture macro data. What was happening with the largest employers in the region? Were they implementing full-time remote work? Were they laying people off or firing them? How many of our residents worked for those employers?
Many laws dictate what an owner can and cannot do with tenants in a residential property. Property management companies know the details, so we worked closely with them to achieve acceptable results. We communicated more frequently with our property management companies, asking them to collect as much rent as possible, even if that meant going door-to-door to talk with residents. We also created plans for the property management companies, like the retail business’s escalating rent payments, to make up shortfalls.
The underwriting models for multifamily properties often include distribution of cashflows to investors over the lifetime of the investment. We worked with our investors to help them understand that a long-term view would yield better financial outcomes for them. Thus, short-term, we agreed to suspend these distributions to maintain the overall investment returns. We also worked with our mortgage lenders to keep investments stable by floating mortgage payments.
Today, we are past the worst of the pandemic’s economic constraints. Hindsight tells us what seems self-evident: During a unique and devastating economic event, we can’t assume that investment projects will operate as planned. Crises make you scramble for solutions. But operating in crisis mode produces ineffective results.
The best practices, even under extreme uncertainty, are to collect and communicate as much reliable information as possible. Having as much information as possible, you can understand what is possible and what you cannot change.
Our definition of success during the pandemic has been to “get through the crisis and not fold,” as Mark bluntly put it. Our metric is preserving our relationships with tenants and our investors, and, above all, preserving our investment capital. And what we learned from this pull-up-your-socks situation will serve us well in the next crisis.
In our next article, we’ll describe how well our overall investment thesis worked for us.