Litigation, vacant spaces: How COVID-19 is shifting commercial real estate
Since the COVID-19 outbreak, however, those Advantage Solutions employees have been working remotely. Although the company still has the space under lease, the offices and parking lot were empty on a recent Thursday morning.
It’s unclear whether the company’s employees will return to the former Klingman’s Furniture and Roger’s Department Store location, since current state guidelines require employers to promote remote work “to the fullest extent possible.” Companies that require employees to leave their homes must abide by numerous safety procedures, including wearing face coverings in shared spaces, adopting cleaning protocols, and following social distancing practices.
This example is one of many ways the COVID-19 pandemic and ongoing concerns about the virus spreading are causing key shifts in the commercial real estate market, driven by remote working and a decline in business activity. The pandemic-led closures also are leading to new litigation over unpaid rent and raising questions about the future uses of space, all while landlords and tenants seek recourse.
For some commercial properties, the pandemic created immediate cash flow challenges as tenants saw steep revenue cuts.
Brad Defoe, a litigation attorney at Grand Rapids-based Varnum LLP, said landlords are quicker to work with smaller mom-and-pop tenants struggling to pay rent than larger companies.
“There is a sense of ‘we’re all in this together,’ so some are willing to negotiate with tenants and will let them pay back rent at the end of their lease or defer payments,” Defoe said.
Conversely, Defoe has seen several recent cases filed in which landlords are suing national companies for back rent owed on retail spaces.
“I think landlords are more likely to file cases like this against larger national tenants because they believe they’ve got the wherewithal to pay,” he said. “It wouldn’t surprise me if we see more and more cases like this.”
To that end, a pair of local landlords have filed lawsuits against clothing store brands owned by San Francisco, Calif.-based The Gap Inc. over nonpayment of rent for retail locations in East Grand Rapids and Holland.
In one case, an affiliate of Jade Pig Ventures LLC, a Grand Rapids-based real estate investment, development and property management company, sued athletic clothing brand Athleta LLC, for failure to pay at least three months of rent for its retail space at 2213 Wealthy St. SE in East Grand Rapids. With the $30,421.33 in back rent, plus attorney fees and other costs, the landlord says it is owed in excess of $75,000, according to the case in the U.S. District Court for the Western District of Michigan.
Additionally, an affiliate of Whitehouse, Ohio-based Devonshire REIT Inc. filed a lawsuit against Old Navy for $85,356.46 in unpaid rent at its location at 12635 Felch St. in Holland, according to federal court records.
Both brands are owned by The Gap Inc.
“The landlord is not asking for possession of the property, and that approach is consistent with what I’m seeing in my practice,” Defoe said of the Jade Pig lawsuit, which he is not involved with and reviewed to comment for this report. “Landlords are just asking for the back rent.”
This is largely because landlords do not want to lose their tenants, especially during a pandemic when it will likely be harder than usual to fill vacant retail spaces, he added.
Occupancy still high
To date, occupancy trends have held steady across the region, according to second quarter data from the Grand Rapids office of Colliers International. The commercial brokerage reports a 3.16 percent vacancy rate for retail space across the region, although it expects more brick-and-mortar locations to close because of financial issues, leading to an increase in vacancy in the coming months.
Retail tenants unable to pay rent during the pandemic may attempt to rely on a force majeure clause in their lease, Defoe said. The clauses are generally included in contracts to excuse one party from its lease requirements in cases of a natural disaster.
For the most part, Defoe said the leases he has seen are landlord friendly and would not excuse a tenant from paying rent because of the COVID-19 pandemic.
“In Michigan, we’re a little different and we don’t have hurricanes or earthquakes,” Defoe said. “But going forward, especially in states like Michigan where we don’t worry so much about natural disasters, I think you’ll see this type of clause negotiated more to account for something like a pandemic in the future.”
‘We have seen a pullback’
Record-high unemployment rates, coupled with Gov. Gretchen Whitmer’s executive order mandating that non-essential employees work from home, have led to a growing number of empty office spaces.
Across the U.S., about half of the people who were employed pre-COVID-19 are now working from home, according to the National Bureau of Economic Research.
Despite having employees work remotely during the pandemic, Advantage Solutions still has “several years left” on its lease at the former Klingman’s Furniture building, said Kirk Driesenga, leasing agent for property owner Hinman Co. of Portage.
However, two former Advantage Solutions employees told MiBiz the company is moving out of the facility at 1001 28th St. SE. As well, the company told workers it would be switching to a remote working format indefinitely, according to an employee who spoke with MiBiz on the condition of anonymity.
Advantage Solutions did not respond to multiple requests for comment.
Driesenga said he has “no knowledge” of whether the company is permanently leaving. Hinman is actively marketing the property, as well as its individual suites.
Jason Makowski, a partner and office specialist at NAI Wisinski of West Michigan, anticipates an influx of office space hitting the market as many companies will likely downsize.
“We have seen a pullback,” Makowski said. “Ever since COVID hit, the office market has been slower. We saw a little bit of a resurgence in the month of June, and from July 4 to today it’s slowed back down.”
According to the second quarter Colliers market analysis, the vacancy rate for office space in downtown Grand Rapids stood at 9.63 percent, and was 6.10 percent for the suburban market.
“Everyone is trying to control costs to the best of their abilities, and office space downtown is more expensive than suburbs, usually because of parking costs,” Makowski said.
Across the board, companies are slow to “rush back” to occupy office buildings, said Don Shoemaker, managing partner at Franklin Partners LLC. The Oak Brook, Ill.- and Grand Rapids-based commercial real estate firm owns industrial and office buildings in West Michigan, Chicago and metropolitan St. Louis, Mo. Many landlords are saying the pandemic is causing a “flight to the suburbs,” Shoemaker said, which would make sense in a commuter city like Chicago.
“There are a lot of people who don’t want to go to the train station full of people and then walk in a street full of people to get to their downtown office,” Shoemaker said.
Franklin Partners is building out spec suites for suburban offices for what he suspects will be a growing number of employers that do not want to work out of downtown high-rise buildings, he said.
Across all of the Franklin Partners’ properties, Shoemaker is not optimistic the company will lease many vacant spaces in the next year.
“It’s almost like a pause button has been hit and everyone just wants to wait and see what happens,” he said.
Another trend Shoemaker has noticed is that most bigger companies are taking a harder line on employees continuing to work remotely. To that end, tech giant Google last week rolled out an extended work-from-home plan for its employees. The company is keeping its employees working remotely until at least July 2021, according to a report from The Wall Street Journal.
Shoemaker’s properties with smaller law firms and boutique shops are quicker to return to offices, he said, while most of the larger corporations do not have plans to come back to their offices until at least September.
Makowski is optimistic that remote working is temporary, and the office space market will start to bounce back because of the benefits of conducting business in person.
“As time progresses and we get vaccines in place for COVID, I think more and more people will start returning to the office,” he said. “Certain companies will continue to test the waters, but I think for a lot of companies, you lose something important when you have all of your employees working remotely.”
Despite the uncertainty of the office space market, Shoemaker said most tenants have continued to maintain rent payments, although tenants in the retail and restaurant industry have continued to request concessions.
“We have and do work with companies that need it,” Shoemaker said. “Overall, our delinquencies are pretty much limited to first-floor tenants like restaurants and hair salons — none of them are paying rent and it’s kind of, ‘OK, we are working with them.’”