As the pandemic continues to spread, its impact on medical office buildings (MOBs) is posing a set of challenges unique to this asset class and putting industry players to the test.
It may be expected that within the commercial real estate industry, healthcare real estate assets, and MOBs in particular, would be thriving given the heavy demand on the country’s medical resources in response to COVID-19. Yet MOBs are not immune to COVID-19’s economic effects. While healthcare real estate has remained more resilient than most other commercial real estate sectors, social distancing and shelter-in-place mandates are impacting a vast number of healthcare professionals, as patients refrain from visiting doctors for non-COVID-19 related medical services.
Landlord/Tenant Relationships
Healthcare providers are experiencing sharp decreases and, in certain cases, complete cessation of their revenue stream as elective and non-critical procedures are delayed or cancelled. Still, monthly rents come due. MOB owners should expect to receive tenant notices anticipating inability to pay rent or requesting rent abatement, deferrals or other relief.
Despite these extenuating circumstances, the lease still governs the contractual relationship between the parties. Some tenants are already taking the position that performance should be excused, citing various legal arguments, including force majeure, commercial frustration and legal impossibility. In each case, the first response should be to review the applicable lease and determine if any of its specific provisions provide guidance.
Importantly, MOB landlords should remain flexible. It may not only be premature to declare default, but may also be prohibited by law. Numerous state, county and city governments have declared eviction moratoria for commercial tenants whose financial hardship is attributable to the pandemic. These rules are fluid and are being updated or amended frequently.
To avoid confusion over waiver or consent, landlords should be thoughtful in their responses to MOB tenants. For example, landlords can respond by providing a tenant with a confidential questionnaire acknowledging the tenant’s financial strain, emphasizing that the contractual terms of the lease still govern the relationship as between the parties, and requesting that the tenant explain how the COVID-19 pandemic is affecting its ability to perform. Careful landlords should tailor their responses to individual tenant needs while protecting their rights at law and in equity.
MOB owners must also review existing loan documentation. Lenders have an interest in these tenant negotiations. Loan agreements often have restrictions on lease modifications and adjustments. If the property is subject to a loan and the lender has consent rights, no decisions with respect to rent concessions should proceed without first obtaining the required consents.
Capital Markets
Despite volatility and uncertainty caused by COVID-19, the capital markets remain open for business. Without the severe credit and liquidity crises at the heart of the Great Recession of 2008 - 2009, many lenders in the commercial real estate market are still willing to deploy capital, if cautiously. This is particularly true for healthcare real estate, given the industry’s relative stability.
For physician groups facing cash-flow difficulties similar to those affecting standard office or retail assets, and for landlords struggling to service debt, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) may provide much-needed assistance. Among other debt-relief initiatives, the historic stimulus package enabled the U.S. Small Business Administration, operating through local lenders across the country, to provide emergency grants and loans to qualifying businesses.
Moreover, most lenders are inclined to cooperate with borrowers, many under compulsion of regulators and the CARES Act. Even without governmental intervention, many lenders are recognizing the universality of the situation and have taken the long view of preserving existing relationships with borrowers. Banks and insurance lenders appear more amenable than servicers for conduit loans. But in all cases, the starting point is a conversation.
Physician groups and MOB owners with loans secured by their practice or real estate should proactively reach out to their lenders and, without admitting an unwillingness or inability to pay debt service, request a “prenegotiation letter.” Such letters set the conditions under which both parties could safely explore their options to open negotiations and navigate a path through this crisis, while avoiding triggering defaults or recourse rights triggered upon a borrower’s written admission of inability to pay its debts as they come due.
Construction & Development
Construction and development projects across the nation are trapped within a grey zone. Shelter-in-place orders vary from jurisdiction to jurisdiction, with some cities allowing activities to continue and other cities forcing shutdowns of all construction sites with only limited exceptions. Emerging trends among the orders reveal critical distinctions between “essential” and “non-essential” business operations. Businesses such as healthcare facilities are typically deemed essential.
This may be good news for MOBs. Before agreeing to demobilize or suspend further work, MOB project owners and contractors should investigate whether government orders at the state and local level allow MOB construction sites to remain operational as “essential businesses.”
On the development front, the entitlement process is slowing due to delays in local government action. Public hearings and counsel meetings have ground to a halt under social distancing guidelines, made worse by the widespread closure of public facilities. MOB developers are finding it hard to get plans approved (or even submit plans), pull permits, receive certificates of occupancy, or obtain other critical government approvals.
State, county and municipal agencies across the country are now scrambling to enable critical stages of the entitlement process to proceed remotely with the help of technology. Although MOB developers and project owners should anticipate slower processing in many jurisdictions, the emergence of virtual development meetings, call-in hearings, and online applications may keep the entitlement process moving, albeit more slowly than normal, in the short term. For those jurisdictions that have halted the entitlement process entirely, applications and permits may be extended indefinitely in conjunction with emergency shut-down orders. The rules often vary widely between jurisdictions, and it is important for developers to pay close attention to applicable expiration dates and local requirements to ensure that no rights are inadvertently lost due to failure to submit necessary applications or take certain actions to perfect entitlements prior to their expiration.
Acquisitions
Shelter-in-place orders also pose challenges to the regular workflow associated with acquisitions and dispositions of MOB assets. One of the biggest obstacles is administrative. Like other “non-essential” businesses and government agencies, title and escrow companies, as well as local recording offices, have shut their doors.
Again, technology is offering viable workarounds. Several states have approved remote notarization (RON), or are working to fast-track such approval, to avoid traditional in-person notary acknowledgements. RON provides a means of certifying an individual’s identity without face-to-face meetings, while also eliminating logistics associated with obtaining original signatures by overnight delivery services such as FedEx or UPS. Moreover, where local recording offices are closed to the public, many continue to offer electronic filings. Working remotely, escrow agents are often able to keep transactions progressing through to closing.
With respect to the due diligence process, shelter-in-place orders have hampered the ability of principals and consultants to conduct site visits, perform physical inspections, prepare surveys and generally kick the tires of any given property. Where due diligence is difficult or impossible to perform, buyers seeking to forward deals may consider sending notices that request extensions, or in the alternative serve as a notice of termination before the deal goes hard. Prudent investors are taking these difficulties into account in requesting additional time to conduct their due diligence activities.
Given the scope and dynamic nature of the pandemic, there is no one-size fits all solution to any particular issue and the guidance above must be considered in the context of your specific circumstances.
David Lari, is a partner, Andrew Fogg is a partner, Scott Abrahamson is a senior counsel and Michael Polvi is an associate with Cox, Castle & Nicholson.
Cox, Castle & Nicholson has created a Task Force to monitor, analyze and advise on a wide array of business and legal challenges arising from the COVID-19 pandemic, including the matters discussed in this alert. Coordinating across multiple practice groups and industries, the Task Force is keeping track of the latest developments with COVID-19 and working to provide the best advice possible to our clients in the real estate industry and beyond.