How CPAs Can Help Clients Navigate COVID-19 Real Estate Trends
Article originally published by Insight Magazine, Spring Issue | By Jeff Stimpson
The lingering concerns and impacts of the pandemic have changed the way organizations rent and buy space. How can CPAs help their clients navigate these shifts?
The last year brought seismic changes to commercial and professional real estate at every level. Some organizations have made remote work permanent while others have downsized or closed their doors forever.
“The major trend right now is uncertainty,” says Mike Demetriou, president and broker at Baum Realty Group in Chicago. “Retailers that were able to survive the shutdowns and COVID-19-related business closures of 2020 may now have an interest in sudden growth for the third quarter of 2021, but few are willing to pull the trigger just yet. The same goes for office tenants seeking to grow or relocate their spaces.”
“Fundamentally, businesses are wondering how to move forward. Many lessees are going out of business and are not paying their leases,” cautions Michael Ludwig, CPA, president of Lombard, Ill.-based Ludwig & Associates Ltd. “Those renewing their leases are often asking for reductions or are trying to break their leases to find cheaper or smaller spaces.”
A New Kind of Office
Steven Joseph, president and CEO at CBIZ Gibraltar Real Estate Services LLC in Chicago, sees several pandemic influences on office users and office space moving forward. Remote work has been largely successful during the current short-term crisis but has some long-term productivity limitations, so flexibility, distancing, reduced density, and health and safety protocols will figure highly in the workplace of the future. However, this new workplace still needs to be a hub for social community, company culture, collegiality, mentorship, professional development, and work-life balance.
Ron Gantner, a partner at Plante Moran Commercial Real Estate Advisors in Southfield, Mich., agrees, stressing that even after vaccinations, health, safety, and social distancing will likely be top of mind for some time. However, Gantner expects limited downsizing. “For years we’ve been reducing our office footprint, in some cases from 300 square feet per person to 150,” he notes. “While it may be easy to argue we’ve proven we can work from home, I don’t see this impacting the commercial real estate market as dramatically as all the available sublease space now would indicate.”
Still, changes are coming. “Property owners will be forced to make significant physical updates to their facilities,” predicts Mary O’Connor, CRE, a Chicago-based partner on Sikich’s forensic and valuation services team. “Most types of real estate will need upgraded ventilation systems, and restaurants will revamp their spaces to create a touch-free environment to better accommodate pick-up and delivery services. A portion of retail spaces will convert to distribution and fulfillment or be used as data centers.”
And while demand for warehousing and distribution space will continue to be strong in support of increased e-commerce, Gantner says traditional brick-and-mortar retail will need to determine if their online sales are cannibalizing transactions from their physical locations, and whether it’s worth carrying both costs.
A Sign of the Times
“Most of our office clients are dealing with surplus space issues—tenants with too much square footage and landlords with too much vacancy—nearly all of which is derived from the effects of COVID-19 on their underlying businesses, or the effects of new work-from-home arrangements,” Demetriou says. “We anticipate a reversion to the mean on this latter issue—workers will return to offices—but those offices may not need to remain in the same configuration as they were. This consequence ripples across retail as well as it could change the makeup of the daytime populations across Illinois. Many of our retail clients, including investors, are wondering where they should risk their capital next.”
“When lease rates start to soften, we anticipate a flurry of deals,” Demetriou adds. Joseph says he is seeing a flood of subleases hitting the market as tenants try to get rid of unneeded space: “Subleases will become a larger part of the vacancy percentage, but many will be challenged by high-density configurations and ways to fund tenant improvements.”
In turn, landlords are likely to lower rental rates, but rental rates can only fall so far given the impact on valuation of a reduced face rate as well as lender limitations. Joseph predicts market weakness will take the form mostly of concessions, like increased tenant improvement allowances and free rent. He says the next 24 months will provide aggressive opportunities for tenants wanting to renegotiate or relocate.
The CPA’s Opportunity
Of course, opportunities for CPAs abound in bad times as well as in good. As business and property owners and leasing, development, and construction professionals all try to navigate these changes, there’s a real opportunity for CPAs to serve as strategic business advisors, expanding upon their traditional service offerings to assist their clients through the challenges ahead.
For instance, the tax treatment of renegotiated loan agreements and debt restructurings, which can modify key terms like interest rates and payment periods, are major concerns for both debtors and lenders now, says Matthew Anderson, managing director at CBIZ MHM in Chicago. Rent payment adjustments are also cropping up, requiring the lessor to consider the proper recognition of rental income when rent is unpaid, delayed, or deferred—common problems during this pandemic. Further, with reduced revenues and vacant space, many landlords could see losses in 2020.
“These net operating losses can be carried back to prior years based on current legislation passed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, so hopefully some of the landlords and investors will get some relief,” says Illinois CPA Society member Kathleen Orlando, CPA, of Kathleen Orlando & Associates Inc. in Palos Heights, Ill.
In fact, the CARES Act and other recent relief legislation offers many chances for CPAs to consult their real estate clients. The CARES Act corrected an error in the Tax Cuts and Jobs Act (TCJA) of 2017, for example, that allows for an accelerated depreciation period for qualified improvement property (QIP), which is any improvement to a building’s interior that isn’t the enlargement of the building.
“The CARES Act corrected the TCJA by changing the depreciable life of this property from 39 years to 15 years,” Anderson explains. “This also provided the added benefit of making this asset class eligible for immediate bonus depreciation.” This change is retroactive, allowing property owners to claim the accelerated depreciation for QIP placed into service in 2018 and 2019 through amended tax returns or a change of accounting method.
Effective tax planning in general will only become more important. “Locally, it’s real estate taxes, service tax, transfer tax, state income tax—a lot of people will tell you that those will continue to be issues until Illinois addresses pension reform,” says Michael Giese, executive director of property services for Glenstar in Chicago. He notes that a recent economic impact study for Chicago showed that commercial office property taxes are up 35 percent since 2012, and ongoing budget and pension issues will only compound the property tax burden.
For many, COVID-19’s impact on state and local governments’ tax revenues is a concern. “The overarching tax consideration for 2021 is the impact on the Illinois budget,” Demetriou says. “The trickle-down could be devastating if municipalities are forced to raise property taxes to cope with revenue shortfalls.”
In tough times like these, CPAs can seize the opportunity to prove themselves as invaluable strategic business advisors. “Where there is great change, there’s always great opportunity for the CPA to assist clients,” O’Connor says.