How to Handle the Coming Surge in Retail Tenant Defaults

While no one knows the severity of economic disruption the coronavirus pandemic will cause, it is likely to hit retail tenants significantly. The shuttering of retailers for an undisclosed period will no doubt create decreased rent payments and potentially tenant defaults.

“According to data from Morgan Stanley, in early March retail traffic dropped 9.1%, apparel retail traffic fell 3.9% and luxury retail traffic declined by 14.7%. As cases of the COVID-19 virus spread throughout the country, retailers will confront plummeting sales,” Sean Southard, a partner with the San Diego offices of commercial real estate law firm Crosbie Gliner Schiffman Southard & Swanson, tells GlobeSt.com.

This is likely only the beginning. “This will, without a doubt, be a growing problem—exacerbated by Governor Newsom’s March 19 executive order requiring everyone in California to stay in their homes,” says Southard. “Because the economic uncertainty caused by the COVID-19 pandemic, rent relief requests and lease workouts will certainly increase as retailers look to landlords for some relief from their monthly occupancy costs.”

In response, some municipalities are placing moratoriums on evictions and foreclosures during the epidemic. “Governor Newsom’s executive order delegated authority to each municipality in California to limit both residential and commercial evictions until May 31, 2020, as each municipality sees fit,” says Southard. “However, municipalities cannot legally restrict unlawful detainer filings that arise from non-monetary defaults, or monetary defaults that are unrelated to the COVID-19 pandemic, although tenants must be able to document that their monetary default is related to COVID-19.”

Even with these restrictions in place, evictions are generally a last resort for landlords, and should especially be in this scenario. Instead, Southard recommends that landlords work with tenants toward a solution. “Maintaining positive tenant relationships and working with tenants who have bona fide needs will allow landlords to adopt successful relief strategies that provide tenants with sufficient relief for the tenant to remain viable, and ultimately return to full health at a cost the landlord can afford,” he says.

Alternative options include workouts, temporary rent deferrals, rent forgiveness, conversion to alternate rent payments, delayed commencement dates, relief from operating expenses and forbearance of exercising rights, according to Southard. “The bottom line is that landlords must understand the affected retail asset, the rights and obligations under the lease for both parties, as well as market trends and conditions as applied to the premises,” he says. “The landlord walks a fine line and can be at risk if they do too much or too little.”

Still, there is limited potential for some tenants to take advantage in this situation. To mitigate against unwarranted requests for relief, landlords should swiftly put systems in place. “Unfortunately, even during a national and global crisis, there are always opportunistic tenants seeking relief when it is not warranted,” says Southard. “Landlords must to have mechanisms and systems in place to assist them in identifying where the real needs are and what tenants are most likely to rebound once the economy begins moving forward again.”