As COVID-19 disrupts the American economy, healthcare system and way of life, retailers and restaurants — the commercial real estate users whose very profitability and essence thrive on social congregation — have already been pegged as immediate casualties of war.
According to data from the U.S. Department of Commerce, total U.S. retail sales fell by 16.4 percent between April and March, well above the projected drop of 12.3 percent. And specifically within the Lone Star State, the Texas Restaurant Association issued a statement in mid-April warning that as much as 40 percent of the state’s restaurants could remain permanently closed as a result of the pandemic.
The month of May has seen Texas emerge as a national trendsetter for reopening retail and restaurant businesses. Texas Gov. Greg Abbott granted restaurants and malls permission to begin reopening on May 1, followed by gyms, bars and bowling alleys during the week of May 18 to 22. All establishments were required to reopen at limited occupancies.
But even prior to the pandemic, landlord and tenants in brick-and-mortar retail were already engaged in a vicious battle against e-commerce. The introduction of COVID-19 has not changed physical retailers’ need to be aggressive, but it has raised the stakes.
To that end, shopping center owners are getting creative to keep tenants in their spaces, largely banking on the hopes that the pandemic will subside in the coming months and that the second half of 2020 will see a strong economic rebound.
Forms of Aid
On March 27, the federal government signed the Coronavirus Aid, Relief & Economic Securities Act (CARES) into law, establishing the Paycheck Protection Program in the process. The initiative allotted $376 billion in financial aid to some 200,000 small businesses. On April 22, new legislation passed to increase the total allotment to $484
billion.
Yet for some retailers, federal aid has been too little, too late. As they are forced to close their stores, many retailers that have been deemed nonessential are finding themselves in cash crunches, with little choice but to appeal to their landlords for relief.
Rent deferrals, perhaps the most common form of relief, can be granted under various terms. One common form of restructuring involves landlords not collecting rent for a couple months from certain stores that are closed, then simply extending the lease by the length of that period and collecting during those months. Other retail owners are only collecting the triple-net items of taxes, insurance and common area maintenance fees in lieu of principal rent payments plus those items.
“Most retail landlords are offering some deferred rent to be paid back over six, nine or 12 months after their retailers reopen,” says Terry Montesi, CEO of Trademark Property Co., the firm behind projects like Victory Park in Dallas and the redevelopment of the Memorial City Mall in Houston. “Landlords can defer rent for a couple of months and amortize it over a period of time after the deferral. In addition, many landlords can and are focusing on helping their tenants have successful reopenings.”
“The length of the amortization period varies from tenant to tenant and is a talking point,” adds Dan Frey, principal at Austin-based developer Endeavor Real Estate Group. “But the communication between the two sides is at an all-time high. Regional and local tenants that have asked for help have not made egregious requests, and landlords understand that it will take some time for business to ramp back up, so these deferred payments are being pushed down the road in some cases.”
Montesi says his firm, which owns and manages about 10 million square feet of retail and mixed-use space, has also helped tenants with basic marketing and social media measures, particularly with restaurants offering takeout service.
Frey also says that in addition to granting deferrals, landlords are offering specific promotional services. These include sending email blasts to inform the public that certain tenants are open, helping with temporary signage and reconfiguring parking arrangements to make takeout and curbside delivery services run more smoothly.
“Our marketing team is utilizing our proprietary digital tools to let shoppers know which of our centers and tenants have curbside, takeout, pickup, delivery and all of these other options that are critical in this environment,” adds Marshall Mills, president and CEO of Weitzman. “They let us communicate in real-time with our tenants so we have the ability to make adjustments quickly. We’re finding that tenants and landlords and lenders are all working together to do what is needed to help us get through this crisis while minimizing any collateral damage.”
Austin-based Endeavor Real Estate Group is finding creative ways to support its retailers, such as converting the Whole Foods Market at its Saltillo project (pictured) into a fulfillment center for online grocery orders. Several other Whole Foods stores around the country are now functioning the same way.
Ultimately, for some retailers, their means of surviving this crisis are predicated on the flexibility and understanding of their landlords. As for landlords, they’d like to keep tenants in place rather than search for replacements.
“Landlords are assertively working with retailers, especially those that have been deemed nonessential and are currently closed,” says Philip Levy, senior managing director at Marcus & Millichap. “In most cases, the numbers work better to just temporarily abate or defer rent, and do everything that you can to try and keep the tenant rather than re-tenant that space, because it’s unclear what the market will be to lease up a potential vacancy when this is over.”
F&B Focus
Other landlords are adopting similar initiatives, especially with their food and beverage tenants. Phoenix-based RED Development, the firm behind The Union Dallas mixed-use project in Uptown, introduced a program wherein employees who work onsite at company properties and in the corporate office could eat for free at all restaurants on RED Development properties.
RED employees could feed themselves and their immediate family multiple times a day for free through April 19, assuming orders were within reason and excluded alcohol. The company’s human resources department reimbursed employees, and restaurants got the much-needed business.
“As COVID-19 continues to bring hardship to communities across the country, we wanted to find a way to not only thank our employees, but also show support for our tenants that remain open during these unprecedented times,” says Scott Rehorn, partner at RED Development.
These kinds of services are especially helpful to food and beverage users, which operate differently from retailers of typical consumer goods and experience-based concepts. With restaurants, much of the inventory is perishable, and training procedures for workers often take longer to implement.
“With restaurants, reopening isn’t a matter of unlocking the doors and turning on the lights as it is for other types of retail,” says Jason Baker, co-owner of Houston-based retail brokerage firm Baker Katz. “And for those restaurants that did have to lay people off, there’s the rehiring, retraining and learning of new procedures that will have inevitably been impacted by COVID-19.”
Baker notes that in Texas, food and beverage concepts have been the most active segment of retail over the last five years in terms of expansions, and that their power as generators of foot traffic has grown considerably. But even among the strongest operators, leasing activity is likely to be scaled back in the coming months.
“There’s going to be a lot fewer deals moving forward,” says Baker. “Even restaurants that can afford to open new locations are going to scale back their expansions. And at the same time, landlords are going to ask harder questions as part of their due diligence. Ultimately both tenants and landlords should emerge from this with stronger senses of discretion and scrutiny.”
Food and beverage, along with fitness and entertainment — the very categories recently held in high demand for their e-commerce-resistant nature — are already feeling the pain. Combined with closures of nonessential retail for other types of soft goods, the net result is going to be a spike in vacancy, Baker notes.
“Ultimately there’s going to be a lot more retail vacancy in every major market in the country than there was prior to this, and with fewer tenants that can backfill that space,” he says.
The fates of Texas-based retailers like Pier 1 Imports, which has announced its intent to close all stores, and J.C. Penney and Neiman Marcus, both of which have filed for Chapter 11 bankruptcy, are already speaking to this trend.
Restaurants that have long held strong online presences and takeout and delivery platforms clearly have advantages in this current environment. For example, Dallas-based Wingstop, which has long been partial to takeout and delivery services over dine-in, reported same-store sales growth of 8.6 percent at its U.S. locations between Feb. 23 and March 28 of this year.
To be fair, fine dining and steakhouse concepts don’t really lend themselves to takeout and delivery. But according to Frey of Endeavor, the outbreak of COVID-19 will, like any drastic economic episode, cause landlords to increase their scrutiny of food and beverage tenants moving forward.
“Landlords should be keen to focus on the extent to which the restaurant has to-go service,” he says. “What percentage of your sales does it comprise? Is your website logistically configured to support that? Can that service be easily implemented? These are going to be key questions moving forward.”
Investment Perspective
Landlords’ willingness to defer or abate rents in the short term does inevitably hurt properties’ cash flows, which can in turn cause disruption in the investment sales side of the market. Levy of Marcus & Millichap says that at the moment, buyers and sellers are largely operating in a wait-and-see mode in terms of deals for assets where some tenants are unable to pay rent.
“All of this disruption happened so recently that the market hasn’t had time to reveal what the actual impact will be,” he says. One exception up to this point are properties with tenants that are deemed essential and are confirmed to be paying full rent.”
“But just as most landlords are working with tenants, most banks are providing some form of relief for their borrowers to alleviate some of the pressure,” he adds. “There are some sellers that do need to free up capital, but they have not yet adjusted their pricing — it’s still too early.”
David Luther, executive vice president of Houston-based NewQuest Properties, echoes the notion that sellers whose properties’ cash flows have been relatively uninterrupted are still looking to move forward.
“We have seen a strong push from owners that were committed to selling prior and are still collecting a majority of their rents,” he says. “We have seen some repricing due to lower rents and/or higher vacancy, and underwriting assets in terms of net operating income has become a fluid situation and requires sellers to be open to rent and triple-net escrows with tenants that request relief.”
Luther adds that in terms of demand, capital sources are still targeting high-quality assets defined by tenant rosters of essential and recession-proof retailers — namely grocers, restaurants, pharmacies and auto repair shops. Investors that traditionally target value-add or distressed deals could also make more splashes in the market should the pandemic wear on and prices become further depressed.
On the demand side, Levy says that his team is still fielding inquiries from prospective buyers, but the pace has dropped off from where it was pre-COVID-19. But he expects the market to benefit from pent-up demand in the third and fourth quarters — traditionally the busiest season for retail investment — as the economy begins its return to
normalcy.
Major pushes to close on the demand side during the outbreak have stemmed from 1031 exchange buyers that must transact within a certain time period to defer taxes. At the time of this writing, the IRS was in the process of extending the identification and purchasing periods for exchange investors to close deals
in 2020.
— By Taylor Williams. This article first appeared in the May digital edition of Texas Real Estate Business.