Why Deferred Rent is No Solution to the Crisis in Retail

The continued presence of Covid-19 is highlighting a reality that not everyone wants to admit: Rental deferments are no solution to the massive challenges in retail real estate.

I have a front-row seat on this: My firm has spoken with more than 100 retail and restaurant companies since the virus hit. In some cases, we’re merely listening to them and acting as a sounding board; in others, we’re formally advising them on strategy and/or executing their lease-restructuring plans. Despite all the pre-pandemic talk of a “retail apocalypse,” many of these once-healthy chains have never been in a distressed situation. And yet today, you can argue that a gigantic restructuring process is the “new normal” for much of the industry.

Here are  four observations from the field:

No. 1: Some tenants set the wrong tone 

Whether you’re talking about retailers, landlords or lenders, none of them did anything to cause the pandemic. But at the same time, the tenor and tone of today’s tough negotiations certainly has something  to do with the aggressive way in which some retailers, starting in early March, responded to the lockdowns.  

To put it candidly, some of their “asks” of landlords were really more like flat declarations made without any visibility into the business impact of the events at hand. A typical refrain: “Our chain, nationwide, will not pay any rent for the next year.” It’s no wonder so many landlords responded with aggression of their own.

No. 2: Most retail and restaurant sales are lagging behind landlord expectations

With the exception of  some tenants—like warehouse clubs, grocers , pharmacies, off-price and discount retailers, and certain takeout restaurants —sales at many retailers and restaurants have been disappointing despite the high hopes associated with re-opening.

In talking with retailers and landlords, what you observe is a significant disconnect with respect to performance: Typically, landlords outside of the harder-hit mall sector have, by now, been expecting sales to rebound by  80 percent. Retailers and restaurants, though, look at their actual results and, in many cases, see sales significantly below that threshold.

No. 3: Deferments—and ‘crossed fingers’—are the norm

The optimism of landlords here could be contributing to the prevalence of deferred rent. Even though many retailers have already lost millions of dollars—it could be years before the survivors fully recover—landlords have shown a willingness to defer two to three  months of rent in 2020 for repayment in  2021. In some cases, they’re simultaneously hamstringing tenants by asking them to waive co-tenancy clauses or make other painful lease modifications.

But is it realistic to expect retailers to be able to pay back these deferrals next year/? Just put yourself in the shoes of the retailer. Will those higher payments be manageable given your margins? In our view, it is much more likely that, for a great many operators, the added pressure will force more store closures and Chapter 11 bankruptcy filings.

No. 4:  Landlords and  lenders need to be flexible 

Landlords and lenders are now in the midst of tough negotiations about how to move forward.

But there’s an underappreciated sticking point: Namely, the practices and norms at many  lenders haven’t changed enough. As a result, these lenders are still taking a reflexively defensive posture: They hired and trained people to respond to landlord requests by digging in and saying “no” or just providing a small and ultimately inconsequential deferral to that landlord.

To work out these problems, landlords need to step up the pressure. Right now, owners routinely (and rightly) ask retailers for proof of their financial distress. In dealing with the banks, they need to come to the table with their own financials and well-reasoned, data-driven arguments. Another refrain is that the die is cast if the property has a CMBS loan, due to the lack of flexibility inherent to a complex capital stack. Not true. There are specialty firms (mine is not among them) that focus on finding new solutions  by helping landlords work around CMBS loans.

Continued operations are in everyone’s best interest 

Getting through the present crisis requires a willingness of all parties to share the pain. Retailers need enough flexibility to restructure their portfolios, whether in or out of bankruptcy, without taking advantage of the crisis. Likewise, no landlord should ever push so hard that every tenant in the shopping center is forced to go dark. Given the seemingly endless supply of inventory hitting the market in the wake of today’s wave of store closures, landlords need to recognize the value of their longstanding partnership with retailers. Otherwise, tenants with leases expiring in 2021 and 2022 are bound to pounce on  relocation opportunities.

And it is time for lenders to give serious thought to what it will look like to take back centers that, with some constructive collaboration, could have continued operating and generating income.

No doubt about it, this is one of the most unfortunate chapters in retail history. Let’s make the ending the best it can be.

Andy Graiser, Co-President of A&G Real Estate Partners, has decades of experience in real estate portfolio strategy, including dispositions, lease restructurings, valuations and acquisitions. You can contact him at andy@agrep.com.