Centralized, tailored decisions needed to avoid CRE crisis

Minneapolis’ historic North Loop neighborhood

Carmichael Lynch is a venerable advertising agency that occupies the top four floors (plus has exclusive rooftop use) of the Wyman Partridge building in Minneapolis’s North Loop Historic District. This year, the company was named a “Best Place to Work” by Ad Age magazine. On its website, the agency describes its value proposition as a consequence of “gathering the best of all disciplines under one roof.” 

I know two of the nearly 250 people who work at Carmichael Lynch; these individuals and their colleagues have been working from home since March with no plans to return to their on-trend, open-floor-plan downtown office space anytime soon. I shudder when I think of all the resources CL has directed toward maintaining this beautiful empty space; I imagine its management team is readying a plan to operate with less square footage in the future. They wouldn’t be the only ones.

A white paper on the challenges facing commercial real estate published this spring by McKinsey & Company argues that the imperative to physically distance from our workplace colleagues due to the coronavirus has changed the demand for many types of space, creating an “unprecedented crisis for the real estate industry.” It estimates the enterprise value of real estate assets has fallen 25 percent or more across all sectors, and dropped much lower in specific ones.

Landlords across sectors are now preparing for tenants to ask for lease concessions or abatement. And while it may be easier for real estate companies to implement one policy across all properties, McKinsey advises such decisions be made on a case-by-case basis, with consideration given to tenant safety, price point in the market, tenant renewal probability, tenant default probability, local regulations, and the potential for reputation harm.

The consulting firm also advises real estate companies to centralize its cash management, acknowledging that in pre-COVID times, decisions impacting cash flow have typically been made at the property level. The report states: “All levels of management — including those at the property level and company level — are beginning to identify efficiency levers and when to pull them based on the underlying performance of properties and the business as a whole. In the past, few properties and companies took a lean-enterprise mentality toward capital and operating expenses. Those that do adopt lean practices and eliminate efficiencies can buy themselves time to work through the uncertainty.”

In our July edition, we reported first quarter commercial real estate lending figures, as seen nationally. CRE loans were up 7.6 percent at banks with less than $500 million in assets, up 9.6 percent for banks with between $500 million and $1 billion in assets, and up 11.2 percent for banks with between $1 billion and $5 billion in assets to the same period in 2019. I expect second quarter CRE numbers will tell a vastly different story.