How might COVID-19 impact Australian Real Estate?
What you need to know
- This article examines the impact that COVID-19 may have on the real estate sector including specific considerations for developers, landlords and tenants, and hotel owners and operators.
What you need to do
- Landlords and tenants may want to seek advice on the impact that COVID-19 may have on their leases, including requirements to pay rent during shut downs.
- Developers may wish to consider whether force majeure or change of law clauses under their development agreements entitle them to extensions of time.
- Hotel owners and operators will need to consider a matrix of issues including workplace safety, contractual obligations and consumer law protections in connection with cancellations plus the impact of COVID-19 on enforcement of hotel management agreement provisions such as performance tests.
With COVID-19 spreading across the globe and the World Health Organisation declaring a pandemic, Commonwealth and State governments are taking unprecedented action to respond to the ongoing outbreak.
The impact of COVID-19 is continually evolving but it is now clear that it will cause significant disruption to business. In this note we consider how the real estate industry in Australia may be affected.
What might be the effect on the volume of real estate deals in Australia?
With travel restrictions, lockdowns and daily changing guidelines, the Australian economy is facing uncertain times. As we know from Brexit, it's not the outcome but the uncertainty (and uncertainty as to how long this may last) that is likely to impact transaction volumes.
Potential vendors and purchasers may prefer to adopt a "wait and see" approach and at a minimum, certain assets classes will likely feel the greatest impact of the international and domestic travel restrictions . However, there remains a weight of international capital still interested in finding a home abroad and real estate remains an asset class of choice.
What are the key risk factors for real estate investors in Australia?
History tells us that real estate investors normally plan to hold their real estate assets as long term assets and are therefore well placed to weather isolated shocks to the economy. However, the longer the COVID-19 crisis goes on, it may become more difficult to raise capital, borrow or service debt and investors may have to consider whether they need to divest themselves of any of their real estate assets.
Many investors may choose to ride out the storm by simply holding on to their real estate assets for longer than they would have otherwise. This will increase the pressure on prime real estate stock with potential purchasers likely to delay making investment decisions in this uncertain climate.
What are the key risk factors for real estate developers in Australia?
Until now the largest challenge for real estate developers has been the ability to source materials and supplies from China. The escalation of the virus across Australia may bring about new challenges such as the supply of labour. If schools and businesses across the country are shut down and workers are asked to self- quarantine, the labour market may be vulnerable to shortages.
Developers are looking closely at 'force majeure clauses' in their construction or development contracts and considering whether they are wide enough to apply to delays caused by the COVID-19 epidemic. In Australia, force majeure clauses are not implied as a matter of law and express clauses are interpreted strictly. What qualifies as a force majeure event depends on the specific terms of the contract and whether a developer may rely on a force majeure clause may depend on the steps that the developer takes to mitigate the effect of the delay. See our note here for further details.
A complete lock down of communities may mean that projects will have to stop altogether, while holding costs and costs of machinery and equipment will continue to be incurred.
This may lead to project delays and contractual disputes and the possibility of parties seeking to rely on contractual or common law rights for relief from the performance of contractual obligations.
What are the key risk factors for landlords and tenants?
Landlords may be putting contingency plans in place to shut down the whole or parts of buildings for suspected or confirmed cases of COVID-19. Landlords will need to consider issues such as:
- if they have rights under their leases to shut down the building in an emergency;
- if they are released from consequential loss as a result of that shut down; and
- if they are entitled to pass on additional costs incurred to clean the building as part of outgoings.
Each lease may need to be reviewed as part of contingency planning.
Landlords should be monitoring the financial health of existing tenants. Tenants in the tourism, leisure and education sectors which are particularly likely to be impacted may approach landlords to negotiate rental concessions or surrender their leases. Tenants may put off major decisions such as taking new space or renewing leases. Landlords should take stock of the tenant securities they are holding and check the terms of their loss of rent insurance should the COVID-19 outbreak lead to significant lease defaults and vacancies.
While force majeure clauses in leases are not common, tenants may look for other avenues to seek rent abatements in the event of building shut downs. Some damage and destruction clauses in leases extend to 'inaccessibility to the premises' and may entitle the tenant to an abatement of rent. Common law principles such as the doctrine of frustration or non-derogation of grant may be relied upon to seek a lease termination or rent abatement.
If tenants have business interruption insurance cover, it will be important to check whether it covers pandemics such as COVID-19.
What issues do hotel owners and operators face?
Hotel owners and operators face additional challenges – practically, financially and contractually.
Hotels are places which are frequented by large numbers of largely transient people, and could also be places at which people seek to self-isolate. It is critical that hotel owners and operators implement processes to ensure the work health and safety of their employees as well as their hotel guests. The attached publication gives a sense of the large scale number of issues that need to be considered and addressed (see the following link).
Contractually, hotel operators are likely to receive increased requests for cancellations and rescheduling of accommodation bookings, tours, conferences and other events. Regard will need to be had to each hotel's terms and conditions of booking as well as the Australian consumer law to assess whether any legal entitlement to a refund (or other right) arises. Ultimately, irrespective of the legalities, hotel owners and operators will also need to consider their long term reputation and relationship with guests when responding to and managing these requests.
Financially, there will clearly be some impact to both hotel owners and operators at least for the short term. Annual budgets may need to be revisited and consideration given to meeting cash flow requirements. Robust cooperation between hotel owners and operators is essential to seek to minimise any long term impact.
Finally, close regard and consideration will also need to be given to force majeure provisions in hotel management agreements and arrangements, particularly in the context of enforcement of performance tests.
Conclusion
We are in unchartered territory at the moment but the advice to those in the real estate sector is to try and be as prepared as possible for further disruption. Consider reviewing the terms of development agreements, hotel management agreements or leases to see whether they contain obligations that must be performed within specified time periods. Seek advice on leases including whether rent and outgoings will need to be paid during shut downs. Engage with counterparties to see what business continuity plans are in place to try to anticipate whether they may seek to re-negotiate, terminate or suspend their agreements.
If you would like to discuss the implications of COVID-19 on your real estate and hotel agreements please do not hesitate to contact us.
If you would like to read more of our legal updates and stay up to date on developments relating to COVID-19 you can click here
Authors: Vicki Aron, Counsel; Lindy Randall, Counsel; Pauline Tan, Partner; and John Stawyskyj, Partner.
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