• Brad Gibbon

Viral Vulnerability: A New Risk Category

Summary


COVID-19 has introduced a new category of risk into the Commercial Real Estate market: Viral Vulnerability. Landlords, tenants, and investors who mitigate this risk effectively will outperform their peers in the market. In order to succeed, commercial real estate needs: a third-party evaluation system, heightened collaboration between stakeholders, and to take action today.


Viral Vulnerability


By now it is obvious that COVID-19 has shaken the world and altered the global economic landscape. With a large fraction of the world’s population under some form of shelter in place requirement, entire industries have had to evolve. The most important question facing every industry is not when we will return to business as usual, but rather what will be the new normal? What measures can be taken today, to prepare for that new reality?


For commercial real estate, we can already begin to see signs of this change. Stakeholders are looking for solutions to bring tenants back: air quality improvements, shift rotations, pre-assigned desks, and the Safe6 distancing rule. Although not all of these programs will be required by the market long-term, it is clear from the discussion that a new category of risk has been created: Viral Vulnerability.


At FastOffice, we define viral vulnerability as the potential of an individual to transmit an infection within an office building. The lower the viral risk, the fewer people will become infected.



Impacts on CRE Value


Viral vulnerability will have far reaching effects on revenue, costs, and other structural risks unless properly mitigated. Landlords, tenants, and investors are asking themselves: what is our vulnerability and how will this impact our bottom line.


Revenue:


Operating in a high risk environment will lead to a dramatic decrease in revenue across the value chain. Tenants will have a higher risk of contracting the virus, being quarantined or hospitalized. They will also not be able to bring clients to the building due to the infection risks. Landlords will see high rates of delinquency and default on their units, leading to higher turnover and vacancy. Furthermore, market rents for high risk buildings will drop, leading to lower asset values.


Costs:


High risk buildings will also produce higher costs. Landlords will need to maintain their building more frequently due to high spread events. Entire floors or buildings may need to be sanitised if the contagion is widespread. This will lead to a much higher cost structure than lower risk buildings.


Structural Risks:


Higher risk buildings will see increased structural risks such as debt and tenant mix. The risk of debt will increase due to the higher costs and lower revenues, leading to lower debt coverage and therefore higher interest rates. Also, we expect higher risk tenants to be attracted to the lower rents that high risk buildings will bring. This higher risk tenant mix will further worsen the rates of vacancy and delinquency within a building.


Outcome:


Due to the negative consequences mentioned above, landlords, tenants, and investors need to take action or risk damaging their business. The good news is that, even in these early stages, many are looking for ways to reduce their risk. However, the industry needs to come together, now, to mitigate its viral vulnerability.


Recommendations


  1. Safety Standard: A third party is needed to evaluate the market and estimate a building’s viral vulnerability risk. This body should also make recommendations of how to improve the building. As in restaurants, buildings need to have their ratings publically available so tenants, employees, and visitors know their risk.

  2. Industry Collaboration: These changes require everyone’s collaboration. Herd immunity will require a large % of tenants to adopt a safer working standard. A building’s risk is determined by its weakest link. However, not all tenants will be financially stable enough to access these resources. Landlords need to lead their tenants by providing resources for improvement.

  3. Don’t wait: Each day we postpone taking action, the bigger this problem becomes. Many of the ways to reduce viral vulnerability require long lead times and high capital expenses. First movers will lower risk faster, retaining value, while slower actors will experience many of the outcomes above. There are ways to act now to lower your risk - such as performing a Safe6 evaluation on office spaces.

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