Safety on the Frontlines of COVID-19

Much like last week, we continue to operate both of our construction businesses and our development business in a more stable environment. While we proceed to put current work in place, we are also focused on signing new work and maintaining a healthy backlog of business. Because of the long lead times necessary to build most buildings, the construction industry typically lags behind the rest of the economy. As a result, 2021’s numbers may show the adverse effects of Coronavirus more so than 2020. Our business was challenged this past week as some states, in our view, are prematurely opening up and putting our employees at a higher risk than we are comfortable with. We continue to respect CDC guidelines and are operating all of our job sites and offices nationwide within those recommendations. As I said last week, detailed planning is underway for how to open up safely when the right time comes.

Industrial development continues to be in a moment of pause. Although there have been some notable new e-commerce leases signed recently, non-e-commerce leasing is slow. Most sales of both land parcels and cash-flowing assets are on hold, as substantial discounts have not yet been presented, but more nuanced pricing in this new environment has not yet been triangulated. Underwritten lease-up time frames and rent growth are both becoming more conservative. Non-recourse lending seems to be less widely available in the short term. That said, industrial real estate is widely expected to be an eventual beneficiary of increased long-term demand. Those who time it well will come out of this successfully.

The shift in tone that I’ve witnessed over the last week has turned from triaging the current crisis to thoughtful planning for the future. Curves are flattening, guidelines for when people can go back to work are being discussed, protective measures for “the new normal” office life are being prepared, and some folks have started to receive funds from the government relief programs. In construction, our active jobs continue to progress, but we are also very busy supporting our clients in pre-development and pre-construction activities. With the increased stresses and uncertainties in deal underwriting, renewed emphasis is being put on feasibility analyses, systems analyses, and constructability reviews. We are busy pricing and repricing a variety of projects right now, and are seeing a mixture of both cost and schedule implications, depending on the jobs. We are focused on finding smart, strategic solutions to the challenges facing us.

The development world continues to see rent reduction requests, slower leasing activity, and a pause in new investment sales. New deals that were on the back burner are under discussion again. We expect that capital providers will re-focus on new investments once the flurry of activity surrounding the PPP loan program quiets down. We have spoken with groups who are developing post-COVID-19 investment strategies based on macro demographic shifts. Others are not planning to overhaul their approach in the wake of the crisis. On every new deal under consideration, the underwriting is being re-visited, with sensitivity analyses and downside scenarios taking a more central focus. Overall, planning for the future seems to be on the top of people’s minds, if not yet demonstrated by their activities.

This past week saw the construction industry continue to move forward in most markets, while maintaining intense focus on health and safety measures. Some officials are reporting increased public scrutiny of jobsite safety, as construction is a highly visible exclusion to the stay-at-home orders in place throughout the country. Thursday’s nationwide safety stand-down focused exclusively on precautions required in the current COVID-19 environment. You will see more masks and social distancing requirements strictly enforced in denser environments. According to reports, 90% of all Chicago area construction jobs are proceeding, and our business is seeing even higher numbers. As current projects continue to progress well, many in the industry are focused on the pace at which new business is being signed. It will come as little surprise that we are seeing a fair number of new deals postponed, although, as of yet, none of ours have been cancelled. One question that has recently been raised is whether construction costs will decrease as a result of a potentially diminished pipeline. Although it’s too early to make broad predictions, we have heard anecdotal evidence of some subcontractors aggressively pricing new work – presumably to shore up their backlog. We will see more clarity on that in the coming weeks.

As mentioned last week, development is facing a wide variety of challenges. Some public REITs have halted all new speculative development to focus on existing portfolios, and have redeployed “deal people” to asset management roles. We have witnessed some layoffs among private real estate companies, although it would be wrong to call it a pattern yet. Other players continue to push forward, seeing opportunity within the disruption. Many land buyers are taking this as a chance to renegotiate deals already under contract – requesting both extended DD periods and pricing reductions. Longer contract periods are more easily given, but, unsurprisingly, I have not heard of many price concessions yet. As both apartments and industrial are widely expected to survive the storm better than other product types, we see good reason to be optimistic in the medium term. Demographics, e-commerce adoption rates, and evolving supply chains will all sustain a decent level of demand for new product. The fundamentals going into the crisis were, on average, healthy. Many markets were supply-constrained, so the risk of an extended and catastrophic rise in vacancy rates seems unlikely. However, as is the case in many downturns, we are expecting a “flight to quality”— meaning robust leasing activity for the best locations and newer buildings will return first.

In comparison to the last several chaotic weeks, this past week has been relatively stable. Work continues on about 95% of our active construction sites across the country. Most municipalities have clarified that construction is an essential business, and we continue to enforce new health and safety procedures. Last week I mentioned potential delays due to reduced crew sizes and the sometimes-slower pace of inspections. Up until this point, we have not seen significant delays due to shortages in materials. However, we have recently been made aware of a handful of large suppliers that are shutting down their North American production lines, which could undoubtedly have significant ramifications in the coming weeks and months. Navigating these challenges effectively will prove critical.

The development industry includes a wide range of entity structures – from private developers to publicly-traded REITs. Unsurprisingly, many of these businesses are facing their own unique set of circumstances and economic pressures, including tenants’ inability or unwillingness to pay their full rent. Many tenants are asking for some form of rent relief. I have anecdotally heard of some creative negotiations that give current relief in exchange for movement on other points within the lease, such as term extensions or removal of termination options. Some development sites look to shake loose as a result of the shift in focus to maintaining existing cash flows. There continue to be opportunities for winners and losers on a deal by deal basis.

The top priority for many this week has been the application process for the Paycheck Protection Program element of the CARES act. Although, in many respects, this has been a moving target, the potential impact that this money could have on the economy should not be underestimated. Many are predicting that the current allocation of funds will be insufficient given the level of demand, and there may be more money approved later on. The scale of the demand for funds from the PPP, as well as the payment (or non-payment) of both rent and loans which were due this week, should provide further insight into our environment next week.

The current environment continues to affect our businesses in rapidly evolving ways. Most municipalities have deemed construction an essential activity and, as such, the majority of our jobsites are pushing forward. However, in some parts of the country, it is unclear if all construction projects qualify as essential activities, or in a couple cases there are conflicting directives from cities, counties and states. Another challenge we see on several jobs is reduced crew sizes, which causes decreased productivity and could result in schedule delays. As can be expected, many new safety practices are being implemented on jobsites, including controlled access zones to enforce mandatory distancing and no-contact thermometers to ensure that anyone with a fever is made aware and sent home. Additionally, to prevent delays while maintaining social distancing, a few municipalities have begun to implement virtual inspections. We have a unique opportunity in the construction industry to lead the way in finding safe ways to keep our economy alive and people working, so we will continue to advocate for safe working environments and continued progress for our clients.

As I said last week, developments are not all impacted in the same way. Some projects in earlier planning stages have been put on a temporary hold, as uncommitted construction debt will be difficult to access in the coming weeks—or even months. For capitalized projects that are seeking entitlement approvals or that are in mid-construction, schedule delays continue to be the most common short-term consequence. In the long term, the effects are likely to vary by product type. A few prominent examples of this are decreased demand for new hospitality developments and increased demand for more affordable housing. In the industrial landscape, leasing is still ongoing but expected to continue at a slow pace in the coming months. Additionally, we are seeing fewer developers take their stabilized or mature product out to market, preferring to let the peak of the crisis pass before exiting their investments. We are also expecting a smaller pool of buyers in the short to medium term. However, there will likely be a long-term increase in demand from e-commerce businesses, as well as warehousing as current inventory levels for many products have proven to be insufficient. We are also anticipating that more companies will focus on diversifying their supply chains, which could bode well for both domestic manufacturing as well as secondary ports.

The current market conditions are impacting construction and development in different ways. The construction industry’s environment is inherently different from the office environment in that it is frequently open air, or individuals are widely dispersed indoors. This setting makes it much easier to proceed with work under current social distancing & CDC guidelines, and we are pushing forward with work on all of our projects with intense focus. The impacts we anticipate on our jobsites will likely be driven by the municipalities in which we are working. Different cities and states are issuing new regulations every day which may impact our ability to continue work. One of the current issues on our active jobsites are challenges getting permits and inspections promptly due to shortages in manpower or remote working environments. In all of our regions, we are proactively preparing for the possibility of a jobsite shut down by ensuring we have a safe and secure project with protected perimeters and roofing in place where possible. Our most significant opportunity and priority right now is to continue to serve our clients as a reliable partner. Hand-in-hand with this is our focus on providing the much-needed income for all of the hourly employees on our jobsites.

In the development world, projects in their early phases are most impacted by the current environment. As referenced above, getting timely entitlement approvals, construction permits and prompt inspections is becoming a challenge. For built projects in lease-up mode, we anticipate things could start to take a bit longer as building tours become trickier and companies pause to understand the impacts on their businesses . That said, at the time I write this, we are still actively negotiating leases for tenants who need space to occupy as soon as possible. Stabilized properties have a bit more breathing room to wait out the storm. Given the uncertainty in capital markets, with the denominator effect likely to play a role, many are predicting short to medium term upward cap rate movement. As a merchant developer heavily weighted toward Class A industrial, this could impact us less severely, but sales that we initially anticipated happening later this calendar year may see a delay. An opportunity we are keeping an eye on is previously controlled sites becoming available again, as some groups may choose to unload. Additionally, we expect that the current surge in e-commerce will have some permanency in the elevated demand – and that bodes well for distribution buildings.