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COVID-19 could lead to rise in customer cancellations in real estate

Investors may have to guard against elongated timelines for liquidation of unsold inventory going forward on account of the pandemic, an EY report has said

July 30, 2020 / 01:50 PM IST

There may be a decline in customer demand and prices as well as an increase in cancellation by buyers as a result of COVID-19 prompting real estate investors to assess the impact of the pandemic on their businesses before investing, stated a report.

A decline in customer demand and prices is expected on account of the pandemic, not to mention the increase in cancellation by customers, the report titled Transaction Considerations Arising Due to Covid-19 has said.

The risk of cancellations would be higher wherein customer equity is lower than the decline in the market value of the unit. There will be a major impact of deferment in cashflows from sold receivables due to delayed payment by customers, the report highlighted.

Investors would also have to guard against elongated timelines for liquidation of unsold inventory.

"Investors such as private equity funds who invest into real estate should factor in their business plan, the increased possibility of the slowdown in sales velocity and possible customer cancellations on the cash flows” Kuldeep Tikkha Partner & National Leader – Transaction Diligence, EY told Moneycontrol.

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As far as working capital and cashflows are concerned, there may be a mismatch in monthly inflows and outflows and increased subvention costs. There is likely to be a funding gap in projected monthly cash inflows versus outflows.

“Given that the potential mismatch in monthly inflows and outflows is likely to go up as payment capacity of customers reduces due to liquidity issues faced by buyers on account of COVID-19, developers should commercially assess the sales velocity of unsold inventory and accordingly plan their cash flows,” he said.

There is also the risk of a potential increase in developers cash outflows under the subvention scheme. There would have to be a management plan in place to service accumulated interest and principal repayment at the end of the moratorium period, the report said.

With regard to claims from vendors and customers, these too may also get delayed.

Investors would have to take into account the ageing of vendor claims and liabilities and agree with contractual terms with respect to idle time claims. Barter arrangement, if any with vendors for settlement of claims/liabilities by the handover of units in the project.

They would also have to keep a tab on the timelines committed, force majeure and customer right to interest claim under customer agreements for delays in handover of the units, the report said.

“Vendors may also ask for idle time claims on account of machinery and labour not being mobilized on the construction site,” Tikkha said.

PE investments in residential real estate amounted to 1,708 million dollars with 31 deals in 2019 and 224 million dollars for five deals in the first half of 2020, as per EY analysis.

As far as commercial real estate is concerned, a weaker outlook for rentals and leasing activity, in general, is predicted. Long term space requirement by tenants may reduce and there may be an impact on mark-to-market premium, the report said.

Investors would have to plan for changes in space requirements by key tenants due to increased work-from-home and higher area per person due to social distancing norms.

It should be noted that some tenants have been adversely impacted by the pandemic especially industries such as aviation, tourism, travel.

In-place rentals with market rentals and assess mark to market (MTM) potential on new leasing/releasing. Industries that may shift to India to de-risk the supply chain and time frame for the shift to happen. A tenant who is outside the lock-in period may renegotiate.

There may also be an impact on revenue and Net Operating Income (NOI) or profits due to rent deferrals and deferment in escalation. Some tenants may enter into long-term renegotiations on lease terms. There may be a reduction in any visitor linked revenues such as the use of parking, restaurants and shopping.

“Revenues earned by investors is likely to get reduced in case tenants ask for lease cancellation or rent waivers. This may dent investors’ revenues. Investors would, therefore, have to keep in mind tenants’ requests for deferment/waiver during lockdown period or plan against legal notices, areas with tenants outside lock-in or leases nearing expiry,” explained Tikkha.

Investors would also have to assess the impact on the Common Area Maintenance (CAM) and other costs.

There may be an increase in CAM cost due to regular sanitation and monitoring procedures, the report said.

Investors may have to re-assess budgets with regard to additional costs due to sanitisation, changes in air filters, scanning of visitors and ability to pass these costs to tenants as also assess tenants’ willingness to absorb an increase in CAM cost post-COVID-19, the report added.

As per EY analysis, PE investments in commercial real estate amounted to 4,418 million dollars for 34 deals in 2019 and about 96 million dollars in the first half of 2020 for five deals.

Moneycontrol News
first published: Jul 30, 2020 01:29 pm

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