The continued presence of Covid-19 underscores a reality that not everyone wants to admit: rent deferrals are not a solution to the massive challenges facing retail real estate.
I have a front row seat: my company has spoken to more than 100 retail and restaurant companies since the virus broke out. In some cases, we just listen to them and act as a soundboard. In other cases, we will officially advise you on the strategy and / or implementation of your lease restructuring plans. Despite all of the pre-pandemic talks about a “retail apocalypse”, many of these once healthy chains have never been in an emergency. And yet one can argue today that a gigantic restructuring process is the "new normal" for a large part of the industry.
Here are four observations from the field:
# 1: Some tenants are setting the wrong tone
Whether they are retailers, landlords, or lenders, none of them did anything the pandemic. At the same time, the tenor and tone of today's tough negotiations certainly has something to do with the aggressive way some retailers have responded to the lockdowns from early March.
To be honest, some of their "inquiries" to landlords were rather shallow statements without showing the business ramifications of the events at hand. A typical refrain: “Our chain will not pay any rent nationwide for the next year.” No wonder that so many landlords reacted with their own aggression.
# 2: Most retail and restaurant sales fall short of landlords' expectations
With the exception of a few tenants – such as warehouse clubs, grocers, pharmacies, off-price and discount stores, and certain take-away restaurants – sales at many retailers and restaurants have been disappointing despite the high hopes surrounding the reopening.
When you talk to retailers and landlords, you find that performance has been severely impacted: Typically, landlords outside of the worst-hit shopping center have now expected an 80 percent recovery in sales. However, retailers and restaurants look at their actual results and in many cases see sales well below that threshold.
No. 3: Delays – and fingers crossed – are the norm
Landlords' optimism could contribute to the spread of rent deferrals. Although many retailers have already lost millions of dollars – it could take the survivors to fully recover – it could take years – landlords have shown a willingness to defer rent for two to three months in 2020 for repayment in 2021. In some cases they are also handicapped tenants by asking them to waive co-tenancy clauses or to make other painful changes to the rental agreement.
But is it realistic to expect retailers to be able to repay those deferrals next year? Just put yourself in the retailer's shoes. Will those higher payments be manageable given your margins? In our view, it is much more likely that the additional pressure will lead to more store closures and Chapter 11 bankruptcy filings for a very large number of operators.
# 4: Landlords and lenders need to be flexible
Landlords and lenders are currently in difficult negotiations about further progress.
There is one underrated sticking point, however: the practices and norms of many lenders haven't changed enough. As a result, these lenders still adopt a reflexively defensive stance: they hired people and trained them to respond to landlord inquiries by interfering and saying "no" or just giving that landlord a small and ultimately insignificant respite.
To solve these problems, landlords need to step up the pressure. Right now, owners routinely (and rightly) ask retailers for proof of their financial hardship. When dealing with banks, they have to come to the table with their own financial data and well-founded, data-driven arguments. Another refrain is that if the property has a CMBS loan the die is cast because a complex capital stack is not flexible enough. Is not it. There are specialist firms (mine isn't one) that focus on finding new solutions by helping landlords process CMBS loans.
Continued activity is in everyone's best interests
To get through the current crisis, all parties must be willing to share the pain. Retailers need enough flexibility to restructure their portfolios in or out of bankruptcy without taking advantage of the crisis. Likewise, no landlord should ever push so hard that every tenant in the mall is forced to go dark. With the seemingly endless supply of inventory on the market following today's wave of store closures, landlords need to recognize the value of their longstanding partnership with retailers. Otherwise, tenants with leases that expire in 2021 and 2022 will have to take advantage of moving options.
And it is time that lenders give serious thought to what it will be like to take back centers that, with constructive cooperation, could continue to operate and generate revenue.
No doubt this is one of the most unfortunate chapters in retail history. Let's make the ending as good as possible.
Andy Graiser, Co-President of A&G Real Estate Partners, has decades of experience in real estate portfolio strategy, including disposals, lease restructurings, valuations and acquisitions. You can contact him at (Email protected).