The economic shock caused by the COVID-19 pandemic and ensuing lockdown has resulted in nationwide store closures, leaving investors to wonder if this novel coronavirus will be the impetus for the demise of traditional retail.
A host of well-known retailers, including J. C. Penney Co., J Crew Group and Nordstrom, already have filed for bankruptcy, or are on the brink of doing so. Lord & Taylor, the oldest department store in the United States, is facing mass liquidation only six years shy of its 200th birthday. Chains such as Dave & Buster’s Entertainment, H&M, Party City Holdco, and Gap Inc. have told landlords rent checks are not coming — at least for the next few months — and asset managers are feeling the pinch.
Brookfield Property Partners, a subsidiary of Brookfield Asset Management, reported April rent collections for its office and multifamily portfolios were, on average, greater than 90 percent, but retail portfolio collections were approximately 20 percent. This is a familiar situation for many asset managers right now and, as social distancing drags on, it’s hard to predict how long it will last and what it will mean for investors in the long term.
AN UNPRECEDENTED SITUATION
While there are some historical precedents, no situation quite like this has ever occurred before. One of our closest frames of reference is the global financial crisis, when the market saw a liquidity crunch, the erosion of net operating income, and widening tenant incentives, according to Manuel Martin, managing director, head of retail sector real estate at Nuveen Real Estate. But unlike previous downturns, the current one was swift and self-imposed.
“We’ve seen economic downturns before, and retail has evolved in response, but this is different,” says Jim Sullivan, a senior adviser at Green Street Advisors. “In the typical economic downturn, spending is curtailed until the economy begins to recover. That will be the case this time, but the health-related considerations create a dynamic that requires a different playbook than we have used in the economic downturns of the past.”
A recent article by Green Street notes the recession of 2020 will put properties in a weaker position than 2008 and will likely result in a number of bankruptcies, despite support from the government. A major difference is that instead of unfurling over a gradual period of time, COVID-19 caused a sharp, very intense change in everything from unemployment to consumer spending, notes Melina Cordero, managing director, head of retail, capital markets at CBRE.
“We will look to certain historical periods or moments in time to try and predict how this may recover and might play out, but the reality is that it’s a very different situation than what we’ve seen in the past,” explains Cordero.
NO ONE-SIZE-FITS-ALL SITUATION
To combat the crisis, some landlords have made concessions for tenants, such as rent deferrals or abatement. Some are also allowing tenants to pay a percentage of rent based on their sales, instead of a fixed rent. Other tenants are examining their contracts for some relief. Subway Restaurants cited a force majeure (also known as an “act of God” clause), contract legislation that frees both parties from liability in the case of an extraordinary event or circumstance beyond the control of the parties, as a loophole to stave off rent payments for the time being. According to industry experts, solutions will be unique and depend on the asset, as well as the type and health of the tenant.
“The decision for landlords is what type of help can bridge the gap between today and when the retailer can reopen,” says Sullivan. “A key question for the property owner is: If my current tenant goes dark, who will the next tenant be, and how much rent will they be willing to pay? The answers to that question will be a key determinant of the appropriate strategy for the property owner.”
The question of who “wins” in this scenario really comes down to one thing: who is able to stay open, which varies widely among retail property types. Essential businesses that have been able to keep the lights on, such as grocery stores and pharmacies, are not only staying afloat, they’re also thriving, according to Cordero. In turn, investors who have grocery-
anchored shopping centers in their portfolios have been shielded from some of the rent issues seen in other parts of the industry. But how does this play out for specific cohorts of the retail sector that were on shaky ground pre-COVID-19?
Malls, which were grappling with their own set of problems before the pandemic, have been hit particularly hard by shelter-in-place orders. According to CBRE, the U.S. average April rent collection rates for malls and outlet centers were between 10 percent and 20 percent, while collection rates were between 50 percent and 70 percent for grocery-anchored centers (the best performers) and between 20 percent and 40 percent for nongrocery-anchored centers.
“What we do know, unfortunately, is that a meaningful number of retailers won’t make it to the other side of this, either because their balance sheets were too weak to carry them through or their retail concept was already faltering, even before COVID,” notes Sullivan.
Indeed, more than 50 percent of department stores that anchor shopping malls could close for good by the end of 2021, according to a Green Street Advisors report.
As for mom-and-pop establishments, Cordero says landlords have made a big push for this cohort. “There’s a huge will across the industry to try to save these tenants because they form such an important and large base of retail, of not only rent but retail and consumer traffic,” explains Cordero. “We’re seeing a lot of partnerships there, and just trying to get money in the retailers’ hands from the government sources that are available.”
HOW DOES THIS SHAKE OUT FOR INVESTORS
Just as some markets are getting hit harder than others, so are some investors. Many REITs, among the largest retail property owners, are grappling with these new rental challenges.
In April, Nareit surveyed 54 listed equity REITs representing almost $418 billion in equity market capitalization. The report found shopping center REITs, which typically own grocery-anchored strip centers, experienced a significant drop in rent collections, to 46 percent of their typical rent, in April. Still, industry experts such as Sullivan and Cordero are optimistic certain REITs, particularly those that were on solid financial footing pre-COVID-19, will rebound successfully.
“REITs use far less debt than the typical private real estate owner, so their balance sheets are in much stronger shape than many owners who compete against the REITs,” says Sullivan. “The strong balance sheets will allow most of the retail REITs to weather this very challenging storm.”
According to Nareit, many free-standing retail assets and shopping centers include grocery and drugstores, which likely contributed to more successful rent collection in these areas. REITs that have a strong pipeline of liquidity are also expected to have more resistance to volatility. Simon Property Group, the largest retail REIT in the United States, is one such company, with about $10 billion in liquidity. Experts are also optimistic about strip-mall REITs and REITs that own properties with grocery stores and pharmacies, such as Kimco Realty Corp., which has a portfolio of 500 shopping centers across the United States. Kimco’s portfolio is nearly 80 percent grocery anchored, and the company reportedly has been successful in collecting rent from its essential retail tenants, according to another Nareit report.
“I think there are other REITs that could definitely face some challenges, especially in terms of their lender situation or their debt situation, because this is not a situation with their tenants and their revenues that’s going to be resolved in the next few months,” cautions Cordero. “This is a longer-term NOI challenge for certain shopping centers.”
Indeed, in the long term, analysts estimate one-third of retailers will pay rent this year, one-third will pay rent at the beginning of 2021, and the remaining one-third won’t pay rent at all, according to Mizuho Securities. How this will shake out for investors remains to be seen, but experts agree there will be lasting effects.
“Near term is going to be painful, as retail is going through a deep disruption in the supply and payment chains,” says Martin. He says this will result in some retailers and operators disappearing.
WHAT HAPPENS NEXT
In a post-pandemic world, Martin foresees a decline in valuations and fundamentals for a period of two to three years. Bankruptcies could be numerous. Occupancy and net income will be eroded, and properties, especially malls, will require more capital to fill the gaps left by failed retailers.
“Long-term normalization as we leave pandemic behind will come slow, on a regional basis and depending on the individual retail asset class,” explains Martin. “We will see new trends in activities — a stronger role of omnichannel and discount retailers, and a slow return of restaurant and entertainment — and a growing role of technology, [with] probably a higher number of picking in-store orders and enhanced cell-enabled visitor control.”
Investors also will have to navigate lower levels of revenue, different rental and cost structures, and less discretionary consumer income in the market, as unemployment compounds nationwide. On a positive note, this presents new opportunities for partnerships between owners and retailers in terms of rental structures, lease language and data sharing.
In general, a major disruption in the market always creates investment opportunities for those with capital. Sullivan says signs of opportunities are already in the public REIT market, where unleveraged real estate values were down 10 percent to 20 percent in most sectors as of May. Unsettling price volatility in the CMBS market will also create opportunities, and the mortgage market could carry some potential, as defaults (particularly on hotel and retail properties) may provide attractive discounts, according to Sullivan. He adds forced sales by cash-strapped landlords and unexpected owners — lenders who come to own properties through foreclosure — may start to arise later this year.
As the industry holds its breath for what has been dubbed the “retail apocalypse,” the shift from traditional brick-and-mortar stores to ecommerce, many are wondering if COVID-19 could be the catalyst. Cordero says although there will be a short-term bump in ecommerce, we will see a bounce back for brick-and-mortar, staving off this dramatic transformation, at least for the time being.
Sullivan agrees COVID-19 will not be the end of traditional retail, but it could perhaps change retail as we know it. “The retail market has always been required to change, evolve and innovate,” he explains. “I wouldn’t call this a ‘retail apocalypse,’ but it will require innovation at a pace we’ve never seen before and, unfortunately, a number of old concepts are going to be left behind.”
Kali Persall is a reporter with Institutional Real Estate, Inc. and editor of iREOC Connect.