Operating Expense Pass-Throughs and COVID-19 Guide

Created with contributions from Marc Fischer, Bespoke Founding Team Partner

Executive Summary

In late 2019, when we first heard about a novel coronavirus that had been identified in Wuhan, China, none of us could have imagined the global impact this microscopic invader would have in 2020 – and beyond. What was eventually named Severe Acute Respiratory Syndrome coronavirus 2 (SARS-CoV-2) – more commonly known as COVID-19 – not only created a global pandemic, but it also precipitated the worst financial meltdown since the Great Depression more than 90 years ago.

The pandemic–induced recession is unlike any other previous economic downturn, and it is unique in its global reaction and reach. Entire countries, regions, and cities have instituted shelter in place orders or were locked down. And, as of December 2020, a second wave of COVID-19 infections has exploded in regions around the world. COVID-19 has forced an abrupt change in the way we work and has precipitated a massive shift to remote working and significant (and lasting) lifestyle changes. These converging factors will have significant and long-term implications for the commercial real estate (CRE) industry.
For many CRE investors, COVID-19 is expected to have a significant impact on operating expense pass-throughs for 2020 – and perhaps several more years into the future: Certain property-related expenses are likely to increase, including:

  • COVID-related deep cleaning and disinfecting costs
  • Additional janitorial service as buildings reopen (high touch point cleaning)
  • COVID-related re-occupancy costs (signage, partitions, hand sanitizer, etc.)
  • COVID-related compliance costs (new protocols, testing, equipment, staffing, etc.)

Certain other expenses are likely to decrease because of the period of reduced occupancy, including:

  • Trash removal
  • Overall janitorial expenses
  • Utilities

Some operating expenses are likely to remain the same,
including:

  • Service contracts
  • Proactive maintenance
  • Landscaping (although some property managers might have deferred certain landscaping costs – like flower rotations – because of reduced occupancy)
  • Real estate taxes

Not all properties will be impacted by COVID-19 in the same way. For some properties, the coronavirus pandemic will precipitate large swings in income, operating expenses, and capital expenses. In other properties, the impact will be
minimal – if at all.

The global pandemic came on quicker and more profoundly than anyone could have predicted, and it will take quite some time to return to “normal” again. Economists’ predictions differ on when we will recover from the Recession of 2020. Some say the recovery will occur in 2021, and others suggest it will take years to recover from such a deep recession.

“We are all in this together” has become a popular catchphrase in the COVID-19 era – one that will indeed be tested as tenants and landlords sit down at the virtual negotiating table. The pain is being felt at all levels – from the consumer up to the lender. Will this result in mutually beneficial lease and loan workouts? In this continually evolving environment, only time will tell.

Read the full Canadian and U.S. reports.