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How Covid-19 has changed the real estate risk and insurance landscape

How we utilise and interact with commercial space is likely to continue to evolve even though the worst of the pandemic appears to be behind us.

The “return to normality”, which began in February when UK Prime Minister Boris Johnson scrapped all remaining COVID-19 restrictions in England, has been welcomed by many individuals and businesses, including the real estate sector. However, the current spike of the Omicron BA.2 variant — 1 in 17 people were infected week ending 22 April — suggests that the pandemic’s impacts are likely to reverberate across society for years to come.

The road to a post-pandemic economic recovery is likely to be a bumpy one and the world of real estate is no exception. How we utilise and interact with commercial space is likely to continue to evolve even though the worst of the pandemic appears to be behind us.

With increasing numbers of office-based employees now returning to their usual place of work, landlords must be aware that the needs and demands of tenants and their staff have changed. Many employees expect to be able to work flexibly, adopting a hybrid approach to time in the office combined with working from home or remotely elsewhere. While many workspaces underwent temporary changes to accommodate social distancing, there is now a shift towards increased collaboration to maximise the time spent working together. This change will require further reconfiguration of the floor plate in order to optimise the space available.

Evolving property risk exposures for landlords

The many adaptations in the way in which tenants use buildings will have long- and short-term implications for landlords’ risk exposure. For example: 

  • Occupancy levels of some buildings will change quite significantly compared with pre-pandemic levels. Sadly, some buildings are likely to be unoccupied for a significant period of time. The vacant space will need to be managed in compliance with unoccupied guidelines and specific consideration given to security requirements.
  • Some assets that were previously let to a single tenant may change to multi-let as occupiers require less space to accommodate employees working flexibly. Landlords will face increased public liability exposure in managing any shared common areas and the transfer of responsibility for the inspection of shared services, such as passenger lifts and other plant items.
  • Some spaces will be completely ‘reimagined’ and put to new uses — a former department store building being transformed into a go-karting track, for example. This changes the risks faced by insurers and may therefore result in changes in policy terms, conditions, and premiums.
  • Tenants also may wish to add amenities and communal areas, such as cafeterias or gyms, to make workspaces more attractive to employees. This can change the risk profile of a building, introducing risks such as the escape of water from shower facilities or an increase in fire risk from cooking appliances and saunas.
  • Reconfiguring spaces may require significant investment and work on the part of both the landlord and tenant. If these works are structural and/or involve hot-working, for example, this represents a period of heightened risk and exposure.

New financial risk exposures could be significant

All of these changes mean that the relationship between landlord and tenant is becoming increasingly important; one cannot survive without the other. There is a greater focus on enhancing existing relationships and being flexible where possible.

One way in which landlords are working with tenants is in the negotiation of future rent payments, with an emphasis on switching to turnover rent. While linking rental income to the performance of a tenant’s business provides a more equitable partnership, this could potentially open landlords up to certain financial risks to which they weren’t previously exposed.

By accepting an element of turnover rent, returns can be severely impacted by a drop in footfall caused by a future lockdown rather than limited to a period of physical damage from an insured event. With typical contingent business interruption insurance coverages, such as prevention of access and loss of attraction coming under increased scrutiny from insurers, this means that landlords may find themselves more dependent on volatile rental income at a time when coverage for such risk is harder to obtain or compromised by reduced monetary limits, restricted scope, or shorter indemnity periods.

Alongside this, some tenants are asking landlords for shorter leases than they did pre-pandemic. While this gives tenants greater flexibility, it adds a degree of uncertainty for landlords about their future income and impacts the ultimate value of the asset.

The macroeconomic impact of the pandemic is also biting landlords. Global inflation, caused in large part by the pandemic’s effects, has resulted in significant increases in the cost of building materials, construction, and energy, among other commodities, products, and services, all of which will be felt by landlords altering or maintaining properties.

In this regard, it is particularly important that landlords ensure that they are accurately reporting building declared values. Reinstatement costs are rising fast and it’s vital that landlords keep their insurers abreast of this to be sure that coverage reflects the value of the property at risk. Good communication between client, broker, and insurer is key.

For landlords, the aftereffects of the pandemic and the changes it has brought are significant and potentially long-lasting. The ways spaces are planned, built, used, and shared going forward will mean changing risks — and opportunities — for landlords. In view of this dynamic risk landscape, it is essential to engage early with your broker to manage, mitigate, and transfer new risks effectively to begin to benefit from the green shoots of the post-pandemic recovery.