The outbreak of the COVID-19 pandemic came at a time, when the country was already struggling with its economic situation, its slackening growth impacting the real estate sector. It was expected that the new year 2020 would resolve the NBFC woes through the various remedial measures announced, confront global headwinds and chart an upward growth trajectory, albeit at a steady rate. The real estate sector, that has been chiefly dependent on the strong performance of the commercial space segment, was expected to observe an all-around growth as well, particularly in the residential segment with easing of the unsold inventory situation through initiatives such as the stressed realty projects fund, lower interest rates and the like. These expectations, as of today, remain challenged by the outbreak of the COVID-19, a prolonged situation carrying serious concerns for the real estate industry of the country.
Impact of COVID-19
In the past few weeks, several scenarios regarding the future of the commercial leasing market have been projected, of which two stand out as particularly prominent:
- Corporates and retailers, both global as well as domestic, are expected to defer their decisions on fresh offtake of commercial spaces by at least a quarter.
- Demand for deferment or waiver of rentals on commercial and retail properties, invoking force majeure/act of God.
Lease Rent Discounting (LRD)
In situations of rent deferment, it is imperative to understand that most organised developers operate on a Lease Rent Discounting (LRD) model where a term loan is offered against rental receipts derived from lease contracts with tenants. The loan is provided to the lessor/landlord based on the discounted value of the rentals and the underlying property value. Currently, around 50% of the commercial developers in key markets operate on LRDs, relying heavily on LRD financing by banks & NBFCs. Major commercial markets such as Bengaluru, that has an office space stock of nearly 165 million sqft, imply the magnitude of dependency on financial institutions by developers on account of LRDs.
On the other hand, the inclusion of the clause force majeure in an agreement implies disasters such as earthquake, fire, floods and other acts of God, as well as to events such as strikes, riots, war declared/undeclared, etc, which renders the tenant of a commercial premise unable to perform its obligations and thereby leads to incurring losses. Only on the occurrence of such catastrophic events that the agreed lease rent and all other charges payable by the lessee to lessors is considered for waiving off or are reduced, owing to the losses sustained and obstructions in carrying on business. In the case of COVID-19 outbreak, however, commercial premises have remained functional with servers operating at desired capacity, providing optimal support to tenants’ businesses.
Impact of delayed decisions and application of force majeure
Needless to say, both scenarios will have a severe impact on the financial condition of a developer/owner of a commercial premise. While the consequences of delayed decisions on office or retail space may not assume critical proportions, it does act as a dampener to developer sentiments and the commercial market momentum, that has been performing well consistently the last few years despite factors such as economic slowdown and implementation of reformatory measures. A vibrant market losing its sheen does not bode well for the economy of a developing nation.
The second instance of alluding to force majeure to waive off rentals is perhaps the single most incriminating point that may impact a developer significantly in present conditions. Currently, the world is reeling under an outbreak that still does not have a solution. While the Indian government has issued a lockdown for 21 days in a bid to contain the outbreak, in our opinion it is still too early to qualify COVID-19 as an Act of God to invoke force majeure by tenants of commercial premises, especially as the developers have ensured that the buildings are functioning at a preferred pace. The situation today can best be termed as ‘wait and watch’ as there is no surety regarding what may occur in the forthcoming weeks. At best, the containment might work, and normalcy can set in. It would then be grossly incorrect to pursue the implementation of force majeure, putting immense pressure on the balance sheet of a developer.
The larger picture
There are deeper connotations to this development. Failure to adhere to bank commitments owing to force majeure being applied and disrupting the LRD model, would eventually impact the liquidity of banks. This, in turn, would have far reaching impact on the economy of the country, thereby hastening the onset of a recession. Thus, what would have begun as a means to augment cost savings on part of the tenant might end up as a catalyst for an economic recession.
At present, landlords are taking up these requests from tenants on a case to case basis, based on the genuineness of the claim/ impact on business.. This attitude would ultimately help in fostering relationships that will develop beyond the current lease term. In return, a tenant’s appeal needs to be credible and practical as well. It needs to be understood that businesses are not carried out in isolation and relationships help in creating valued opportunities in the long term.
It is, therefore, in the interest of the well-being of businesses and the economy that every faction related to the real estate sector should act responsibly