Commercial real estate owners across all industries are reeling from COVID-19’s impact. Hotel occupancy plummeted in mid-March and now sits at about 40% nationwide. Retail rent payments fizzled and while office rent payments remained strong in the 80%-90% range, many tenants and owners are still working on rent abatements or lease extensions. The resulting uncertainty has one common impact regardless of the real estate sector: CapEx spend is frozen.
According to publicly available Q1 2020 REIT investor reports, approximately $600M of previously announced CapEx spending in 2020 will be deferred. One office REIT in the top ten of market value announced in Q4 2019 it would spend approximately $500M on development and repositioning to earn a 5-7% yield. At the end of Q1 2020 it announced it would put $73M in “discretionary CapEx” previously planned for the rest of 2020 on hold.
Based on the age of most commercial buildings in the U.S., many CapEx budgets were headed towards modernizing existing assets — like replacing end-of-life equipment — and to reposition them for increased rents or occupancy. Moreover, when unemployment insurance extensions expire at the end of July, rent collections could begin to falter and the amount of CapEx deferrals could very well increase, putting further pressure on net absorption rates. Real estate owners will have to make tough choices between investing in existing assets, forgiving rent, and making debt service payments.
As we enter peak summer we’re also entering the heat of the 2021 budget cycle. Here are 4 challenging questions owners face and recommendations to help them navigate the uncertainty ahead:
How much failing equipment was slated for repair or replacement in 2021? Does that supersede the CapEx placed on hold from 2020?
- Focus on what’s costing you the most money. Is a leaky valve jeopardizing an anchor tenant’s happiness? Fix that before you convert a parking lot into a disc golf course.
- Carbon Lighthouse engineers use advanced sensors to evaluate where you might be leaving money on the table in your HVAC or lighting systems and help align recommended corrective measures with larger business goals.
Who is going to manage this glut of CapEx projects when it’s safe to begin construction again? Hotels especially will feel this crunch as they’ve trimmed down staff to the bare minimum.
- Figure out what your team is good at and be honest about where they need support. Many property management firms charge markups on managing improvement work in buildings. This could be a good time to rework those agreements if a qualified third party can provide the same or more value.
- Carbon Lighthouse manages end-to-end energy/HVAC/lighting/solar upgrade projects with transparent fees and AI-driven optimizations to make end-of-life investments yield more NOI than a traditional replacement.
How should owners confidently prioritize the glut of required CapEx work with upgrades needed to make buildings more resilient to virus transmission and to ensure occupants feel confident in building safety?
- Review vendor contracts carefully for what their actual deliverables are. Identify a specific financial return for each dollar of CapEx invested. Deeply question assumptions and estimated returns from vendors, especially since COVID could have impacted what vendors can still deliver.
- Carbon Lighthouse is clear: we guarantee a financial return for 10-20 years for each dollar of investment.
How should owners source capital for this glut of CapEx projects?
- Seek financing sources with non-recourse debt that don’t run afoul of the primary debt holder on the asset and take the least amount of fees and markup. Ask questions like: What’s your cost of capital? What’s the implied cost of capital after your fees? What percent of your profit comes from financing?
- Carbon Lighthouse doesn’t take a lien on the underlying asset and has access to a debt fund with a transparent cost of capital. Carbon Lighthouse also takes no additional profit on the financing.
While many uncertainties lie ahead, owners and investors must continue to drive their investments forward. Asking the right questions, partnering with the right vendors and making data-informed decisions will help mitigate the challenges that lie ahead.