By Alex Patton
Retail real estate investors in Boston are cautiously evaluating the risk profiles of tenants even as businesses reopen following temporary closures due to the COVID-19 pandemic. The emerging consensus is that until a vaccine is developed to safely treat the virus, the safest investments are tied to essential tenants with reliable incomes. That short list includes grocers, drugstores, home improvement businesses and liquor stores.
Like the rest of the country, all nonessential retail businesses in Massachusetts were forced to close temporarily in early March, for what was originally expected to be a short period. After several weeks, the commonwealth’s government implemented a phased reopening system that allowed some retail businesses to resume operations. However, after months with significantly reduced income, a number of small retailers are declaring bankruptcy and permanently closing stores to save money.
“The underlying question that permeates the retail investment industry, as an investor or a lender, is how much of the income is durable? In other words, which retailers are going to survive?” asks James Koury, senior managing director of investments at the Boston office of Institutional Property Advisors (IPA).
“A vaccine would be a game-changer, but we can’t know if it will be six months or a year before we see that, and many small retailers won’t last that long with this reduced income. Lenders are looking at this in a bifurcated manner, investing in assets with essential tenants and durable revenue.”
Defining ‘Essential’
Federal and state governments deemed retailers — including supermarkets, drug stores, home improvement stores and liquor stores — as “essential” at the start of the pandemic, meaning they were allowed to stay open and saw continued revenue, even higher levels in some cases.
Retailers that are well capitalized and dominant players in their markets, like specialized department stores, are durable but not necessarily essential. Koury says that while not all durable tenants are essential, all essential tenants are durable, and lenders still consider both to be secure investments during the pandemic.
In the Northeast, grocery chains like Stop & Shop, Wegmans and Whole Foods Market have remained open since the beginning of the pandemic, providing essential goods and keeping their staffs employed. While other businesses have been forced to lay off employees and close stores temporarily or even permanently, grocers have had to increase their part-time staffs to meet the demand for goods that were flying off the shelves faster than they could be replaced.
“Some people are saying that retail as an investment vehicle is in trouble right now, but that is only because they are painting the retail market with one broad brush. I can’t imagine a better investment vehicle than durable, essential retail,” says Koury. “A well-located, single-tenant grocer is not just going to survive a pandemic, it is going to excel.”
Koury again references the concept of “durable income” in his endorsement of all types of grocers, as much of Americans’ disposable income is being transferred to grocery spending via closures of dine-in restaurants. To the extent that consumers are struggling, they may switch to a lower-cost grocer, but the sector typically retains strong brand loyalty among shoppers, Koury says.
“There may be some instances of certain grocers gaining greater market share in this environmen, but really it’s more like a rising tide lifting all boats,” he says. “Simply put, all grocers are benefitting to some extent from the fact that people are eating more at home and less in restaurants.”
The big question that retail property owners and investors are wrestling with right now is how to trade properties with “less durable” in-line tenants, such as restaurants and hair salons.
One solution Koury suggests is for the buyer to request an escrow account be established, whereby the seller of the property will guarantee rent payments over a certain period of time in the event a particular tenant at the property is unable to pay the rent.
Uneven Reopening Regionally
In urban markets, some retail centers such as CambridgeSide in Cambridge have experienced less daytime foot traffic because the surrounding office buildings are only allowed to be at 50 percent capacity, says Issie Shait, executive vice president of property management at New England Development. The Boston-based developer is the owner of the 1-million-square-foot CambridgeSide.
Some retailers at CambridgeSide, New England Development’s 1 million-square-foot shopping and dining destination in Cambridge, have been impacted by decreased foot traffic from nearby office buildings. However, having a durable roster of tenants that includes the likes of an Apple store (pictured) will help the center in the long run.
“However, local families and residents are spending more time closer to home and at the center. As key retailers such as Apple, Old Navy, Sephora and T.J. Maxx have reopened, we have seen a steady rise in foot traffic.”
Major retailers at CambridgeSide include Best Buy, Macy’s, CVS, an Apple Store and numerous restaurants and other retailers. The property also features a 236-room Kimpton Marlowe hotel and waterfront green space.
Shait says that approximately 90 percent of retail tenants across New England Development’s portfolio had reopened as of July 1, and that the company continues to see leasing interest from both national retailers and small businesses at its properties. New England Development also continues to move forward with retail, office, lab and residential developments at CambridgeSide and Allston Yards in Allston, Massachusetts.
Multi-Tenant Assets Suffer
“During the pandemic, investors are looking at different asset classes to evaluate their longevity,” says Robert Horvath, executive vice president at Horvath & Tremblay, a Massachusetts-based investment brokerage firm that specializes in net lease assets. “The multi-tenant side is harder to transact because not all tenants will be able to reopen anytime soon — maybe not at all.”
Horvath emphasizes that retail properties in Boston and greater New England are still in demand by investors, but there is a tendency for investors to choose tenants that have essential businesses that serve the local community. With significantly reduced numbers in tourism and out-of-state customers, investors are more likely to make safe investments in assets with essential and durable tenants.
“What we’re finding is that the essential service-type assets in the net lease world, including grocers, drug stores, dollar stores and automotives are very much in demand,” says Horvath. “There’s a flurry of activity because investors want to capture that increase in demand.”
Experiential Concepts Reeling
While net lease retail properties are reopening and shoppers are steadily returning, the family-owned and independent businesses that give cities their character and attract tourism remain in danger of permanently
closing.
Robert Elmer, a managing principal with Lee & Associates based in the brokerage’s Boston office, says that in recent years, restaurants have been expanding in two general business directions: delivery and experiential. Restaurants usually partner with third-party services such as Uber Eats and GrubHub for delivery. Experiential restaurants normally emphasize higher-end service, presentation and ingredients.
“Experiential dining was killing it a year ago, but this pandemic has changed everything,” says Elmer. “No business would say it has completely figured out the best way to operate in these conditions, but some are adapting better than others. While some are just worried about survival, others are actually improving their business during this time.”
Elmer says that restaurant chains that serve items like sub sandwiches, pizza and Asian food had already embraced a culture of delivery and takeout before the pandemic struck. Consequently, chains like Jersey Mike’s have survived and even thrived amid the pandemic.
Experiential restaurants have had more difficulty adapting to delivery, as higher-end meals are often too delicate to deliver with the same quality as they would in the restaurant. Steaks, for instance, are meant to be served at precise temperatures and sometimes arrive undercooked or overcooked when delivered.
Some have gotten around this by delivering meal kits instead of prepared meals, but this requires customers to cook the meal themselves, removing much of the convenience of food delivery.
While restaurants have generally been allowed to remain open for takeout, delivery and curbside pickup service since the beginning of the pandemic, many have seen a sharp decrease in revenue as a result of closed dining rooms and limited alcohol sales. Many of them, especially family-owned and
single-location restaurants, will have to close permanently. Those that are able to stay open are doing everything they can to pay their staff enough to stay working with them.
“If restaurants can’t pay their staff enough over a couple months, they’ll have to go somewhere else to work,” says Elmer. “Holding on to employees through the pandemic is preferable to hiring and training a whole new staff when the restaurants are allowed to reopen.”
Although restaurants in Boston could operate limited indoor and outdoor seating for dine-in customers at the time of this writing, it’s hard for anyone on the ground there to say when small businesses will be able to recover from the unexpected tank in their revenue.
Arguably more important than food sales, restaurants and bars rely on alcohol sales to make the lion’s share of money. Massachusetts categorized bars differently than restaurants, slating them to reopen along with entertainment retail and other social businesses.
“Until there’s a vaccine, it just won’t be safe to reopen completely,” says Corey Bialow, chief executive officer at Bialow Real Estate LLC, a Massachusetts-based real estate consultant firm. “Restaurants with a larger footprint are more conducive to creating an environment that allows for social distancing. For smaller retail stores to be successful in this environment, they need to maintain an omni-channel platform that will allow customers to shop online and pick up at the store.”
Small entertainment businesses that were previously gaining traction, such as escape rooms, axe-throwing ranges and performing arts venues, rely on ticket sales and events for virtually all of their revenue. While some consumers may be excited to go to entertainment businesses, those proprietors are not likely to make enough revenue to justify the expense of reopening.
“We’re still in this environment where a lot of people aren’t comfortable going out even if they are allowed to,” says Bialow. “When you’re wearing masks and gloves in a store and have to get your temperature taken at the door, you almost just want to get out of there as quickly as possible. They say shopping is America’s pastime, and this virus has taken away the entertainment value of the experience.”
—This article first appeared in the June-July 2020 issue of Northeast Real Estate Business magazine.