David Brush is Chief Investment Officer at Merlin Properties, the largest Spanish REIT, which owns the flexible workspace brand Loom
Ben: Hi, I am Ben the CEO of coworkintel, the authoritative source of premium operational performance data for flexible workspaces. Today, we have David Brush who is the Chief Investment Officer at Merlin Properties - the largest Spanish REIT, which owns a flexible workspace brand called Loom. Hi David.
David: Morning Ben. How are you?
Ben: Very well, thanks. So David, let's start by giving some context on the impact of the virus on the real estate sector. Given the broad portfolio of Merlin Properties, you have a rare point of view on the real estate sector as a whole including flexible workspaces. Have you observed any difference between retail and commercial, long-lease and flexible?
David: Yes, I think you know today we're involved in retail, warehouse logistics and offices: within offices we have both long leases "triple net leases", and flexible spaces as well through our Loom brand so we do cover the spectrum of property. I would say the most affected as you can imagine has been retail with 77 percent of all of our retail tenants forced to close.
In warehouse logistics we're seeing positives
So, there we've got a meaningful number of those tenants that are not operating because of the essential services provider requirements in Spain and that's by far and away the most affected. Offices much less so. In warehouse logistics in fact, we're seeing positives because there's more demand for space now from tenants who've either had to store things that are not going into the stores or because their own activity is quite a bit accelerated.
So that's been the least affected and then net leases really again no effect whatsoever. We have large corporate clients in this space, so we see no real risk of non-payment in that area. And then there is our flexible business. 80% of our tenants in flexible are actually large corporates and 20% are start-ups /scale-ups, so depending upon which category a user is in, there has been different degrees of reaction.
The larger corporates have much less, I think, stress on them than startups and smaller companies who have not a great deal of runway if you will, not as much financial flexibility - they have been affected to a lesser degree.
Ben: Sounds good. Thank you. You are based in Madrid, which was one of the first occidental market hit by the current crisis. Tell us how it started and how have you have reacted to it so far?
David: Yeah. Well it really emerged quite quickly. Italy was the first country in Europe to go through the experience, the rise of the contamination and its impacts and went into lockdown sooner.
But Madrid was immediately after this as you commented. The first thing we focussed on was how do we change our own business operations - that was the first that we thought about and we actually ended up implementing a work from home strategy for the company before the state of alarm was announced in Madrid. We started work from home on the 11th of March and the state of alarm state of emergency in Spain was on the 15th of March.
We wanted to be out in front of it. We have 250 employees. So implementing that change was a real operational challenge. Fortunately we were well prepared for it. And so we made the transition pretty smoothly from people being in the office to working at home and we had no issues with cybersecurity or connectivity.
The only place where people had to actually continue to go to work was within our shopping centers because those were staying open. You needed people on-site, so we basically divided them into two different teams. In that way, not everyone was there at the same time to ensure that the sanitary conditions were maintained properly. We had teams working in two week shifts and then they would take two weeks off to keep them completely separated. In terms of the flexible space we went to a policy where the hosts would be working remotely. So we kept all of our spaces open but we had our hosts connected online to support our users. So, if people needed support from the hosts, it was available. That said, we have had very few people coming to the spaces, given the shut down orders. We also started to implement a lot of online webinars about the issues that were important to the local communities so they could see how others were reacting to the crisis.
We polled our tenants and users as to what things they were concerned about and could use support on and we organized virtual sessions so that people could share those experiences and understand what others were doing and what are the resources they could find and basically just an open forum for communication amongst all of our users, which I think they very much appreciated.
So that was very much in the early days. Then we had to start to deal with some of the issues of how we deal with some of the difficulties that our tenants are going to have and we decided to take a client-oriented strategy and be proactive.
We took a strategy to be proactive and client-oriented
In retail, for example, all those retail tenants that were forced to close we basically implemented a four-month rent abatement.
We made that program eligible to people who are up-to-date on their current payments so it was only eligible to people who were in good standing. We also said that going forward tenants would be responsible for their ratable share of the operating expenses of the center, which was consistent with their lease contracts, but we would grant a four-month abatement on the rent. That was actually the earlier of four months or whenever the state of alarm was removed in Madrid and I think by doing that we got a lot of very good feedback from our tenants and many who were threatening to pay nothing, even their operating expenses, signed on to this agreement.
So I think we ended up getting very positive feedback on the fact that we were proactive, not just waiting for what the government would require. I think in the end we probably end up in a better financial position because we secure the payment of operational expenses from those tenants.
Within the flexible space, as I said earlier, 80% of our tenants are actually large corporates and 20% are startups and scale-ups or smaller entrepreneurs. We divided those into two buckets and basically went to those entrepreneurs and offered them a 50% rental discount, initially from the 15th of March - the date the state of alarm was put into place - to the 15th of April.We've now extended that to the 15th of May. So again, before anyone called and started asking for discounts or before there was any kind of government edict on discounts, we proactively put this program into effect.
Ben: So, thank you. So to summarize perhaps your recommendation is to landlords in markets that have not yet experienced the gravity of the situation in Madrid would perhaps to 1. react early and 2. be tenant focused.
David: That's exactly it. I think it just amplifies what is already becoming more true about the real estate business. The days of Real Estate companies being investment companies: buy a building do a 10-year lease and then talk to the tenant nine and a half years from the day you sign the lease as to whether they want to renew or not. Those days are gone. I think our response to this crisis has just been an amplification of that trend: be tenant focused and be decisive: respond early.
The days of Real Estate companies being investment companies: - buy a building,
- do a 10-year lease,
- and then talk to the tenant nine and a half years from the day you signed as to whether they want to renew or not.
Those days are gone.
And one thing I would say as well is, and we've really tried to look at this way: We did not want this to become a legal battle. Right? I mean, obviously, there are going to be legal issues that come out of this for a lot of people but we said if we can find a way to actually make this a tenant and client user-driven experience if we can actually be responsive then that will limit the number of legal issues we might have at the end.
And hopefully we come out of this with a stronger relationship with our clients because we did act proactively in trying to help them upfront, but I'm talking particularly about the SMEs and smaller tenants. Large corporates you kind of feel like we're all in this thing together, you know, we're going to suffer a little bit but we're in a strong enough financial position to endure it. You're going to suffer a little bit too. But you're in a strong enough financial position to endure it as well.
We're trying to focus on those clients and users that are not in a strong financial position and their whole survival may depend upon what we contribute.
So that's really where we've been focusing our efforts in the support that we've been giving to people.
Ben: Right the reaction from the demand has been on the large corporate side resiliency and on the smaller enterprise side very strong feedback for your approach.
David: Yeah, and I think again it's worth looking at our flexible space. We have had less than 5% fall out so far from the leases that we had in place. I think that is remarkable when you look at some of the numbers I'm hearing. WeWork, for example, went from something like 85% occupancy to 60 percent occupancy globally - a number I saw in the FT a few days ago.
I think it's worth looking at our flexible space. We had even less than 5% fall out so far [...] which is remarkable.
So since the beginning of this crisis to Monday of this week, we had only a 5% cancellation rate from our existing tenants. And I think part of that was the effort that we took in supporting them.
Ben: Do you work based on some anticipation of the end of the lockdown or do you focus more on more immediate priorities at the moment? What's your feeling?
David: We're starting now to focus on the reopening because if you look at Spain, it has been under a very significant lockdown and so even construction projects have been halted for the last three weeks. If things work the way we hope, then we will start to see some relaxation of the conditions sometime next week.
So you'll be able to start construction projects again, and so we can go back in and do the fit-out work that we were planning in some of the projects that we've got ongoing.
So, how do you do that? Right either you've got to make sure that the people going in to these spaces are going to be safe. You've got to have protocols in place.
So what we are working on now is how do we ensure that? How do we have the proper protocols in place. How do we ensure that we have people feel comfortable coming back to the spaces that we operate?
That means things like accelerated cleaning schedules, more deep cleaning with more intense sanitization as part of the process. So you have to have different protocols for how you take care of the space and then different protocols for the construction projects again, you know, how many people are on-site? What kind of testing is done for those people that will be on-site?
So those are things that we're working on now and then if you look the longer term right now the state of alarm in Madrid has been extended to the 25th of April. That's probably something that I think is still dependent upon data.
If you see now that Denmark and Austria are starting to reopen a bit, China has reopened, Singapore reopened but then they've had to put back in some more restrictions because the infection rate started to rise.
So I think so much of this is data dependent, but we are planning for what happens when things reopen because we do believe that in Spain that will likely be in the early parts of May. So we are thinking about preparing for that.
Ben: We really look forward to this date for sure.
David: As a Spaniard would say "Ojala!"
As a Spaniard would say: "Ojala!"
Ben: [laughs] Another I imagine very challenging part of the work those days is the relationship with your shareholders and your lenders. Is there any recommendation you would make on that on that front.
David: Yeah. Well, we're in a bit of a unique position, because when you look at our financial situation, our balance sheet is very strong. We don't have any debt maturities within the next two years and we drew our revolving credit facility, so we have €1.1 billion in cash on the balance sheet.
So we came into this thing in a very very good position and then secondly most of our debt is corporate-level debt. So we don't have a lot of secured asset financing where the lender would be worried about it.
You know, if an owner has a high exposure to flex in a building where they have a secured mortgage, they are going to have problems. We're a little bit different.
Finally, at the aggregate level with our investors and shareholders today, only one and a half percent of our €450 million rent comes from flexible space. You're talking about a very small percentage of our business, so our exposure to flex is not a big issue, neither for our lenders, nor for our shareholders at the moment.
Ben: That makes sense. Now, perhaps to finish this interview how you think the industry and in particular the flexible workspace one could position itself to benefit from the rebound after the lockdown or at the very least to recover some of its losses
Yeah, I think it's a little bit difficult to be clear right now about how things are going to change in the future. Things will clearly change. You don't go through something of this magnitude without people changing the way that they do business, but I'm not sure at this point how much that change is going to be.
I do think that it will again accelerate this trend toward flexibility, because this experience adds even a further level of uncertainty in the future. No one had a pandemic playbook for their business before Covid-19
No one had a pandemic playbook for their business before covid-19
But,while people didn't have a pandemic plan previously, this will be part of people's risk planning going forward. So, if you have a situation where you have another risk factor, which you have to plan for, you're going to want to have more flexibility.
Flexibility and diversification are the two tools you can use to manage risk in a business. So I think going forward people will likely want to have this degree of flexibility for a portion of their portfolio of space because they may need to react more quickly to reduce cost in the event that there another event like this in the future.
So that's part of it. I also think that as we emerge from this crisis, that by using technology to make our spaces safer, more secure, we can give more confidence to our users that we are taking an extra step in terms of creating more safety and security in the space then I think we can use that as a tool to attract more people to do flexible spaces.
And so I think in the end this will probably have a positive impact. I don't know how positive. And again, I think it just amplifies trends that were already in place, but it will change the curve of how quickly I think some of these are adopted.
Ben: That sounds very good. Thank you David. That was great. I wish you a confinement as short as possible.
David: And to you and I appreciate the opportunity to speak to you
Both: Bye bye!