How Commercial Real Estate Owners Are Managing Rent Defaults

June 10, 2020

As businesses begin to re-open across the U.S., commercial property owners are coping with rent-collection woes triggered by the COVID-19 pandemic and protest-related property damage, which was reported in at least 25 cities. The retail and hospitality sectors have been especially hard-hit. Owners of 30,000 strip malls in the U.S. received just 30 to 50 percent of April rent, according to Green Street Advisors.

Non-payment of rent, which can lead to mortgage default, is complicated by the uncertainty of COVID-19, said Curt Spaugh, a SitusAMC Director focused on special servicing. “When a lender has a sub-performing asset or one in default, we try to determine if it’s an issue with the sponsor, the asset or the market in general, to guide the appropriate loan restructuring or workout,” he explained. “But we don’t know if the coronavirus is a six-month issue or a longer-term liability. Because of this, we’ve taken an agile approach, providing our clients the flexibility to adapt as we gain clarity on the market.”

Publicly traded operators of outdoor shopping centers, particularly those anchored by supermarkets, should have the balance-sheet strength to weather the crisis, analysts suggest. For example, Vornado Realty Trust, which owns 2.3 million square feet of street retail in Manhattan, noted in its May earning call that while all other types of retailers had reached out for financial relief, grocery stores and other essential tenants have not. Meanwhile, indoor malls featuring department stores, restaurants and entertainment venues are more at risk, as a number of national chains have announced they would not pay rent in April and May.

Getting Creative

“Some owners are proactively offering a ‘blend and extend’ lease renewal,” Spaugh noted, especially for tenants who are a year or two away from lease expiration. “Landlords may offer immediate relief in exchange for tenants signing a new, longer lease. These deals can include short-term suspension of rent with the balance paid off over time.”

Owners’ negotiations will focus partly on addressing co-tenancy clauses, which allow retailers to terminate their leases or pay reduced rent if the shopping center’s anchor tenant leaves, or occupancy falls below a certain level, said Ted Wright, a SitusAMC Director specializing in asset management. “Sponsors may have a matrix of a dozen of co-tenancy clauses,” said Wright. “Co-tenancy clauses can have a domino effect. Once you lose an anchor tenant or two, it starts cascading, and the losses can be significant. We expect negotiations on co-tenancy clauses to accelerate in this environment.”

Government Intervention

Another possible avenue for landlords: Property tax disaster relief. Eleven states have disaster provisions that allow landlords to reduce or defer property tax payments immediately, according to Globe Street. For example, California’s statute provides relief if a property has been subject to restricted access, which would clearly be the case for properties closed by government lockdowns.

Under normal circumstances, leases continue until tenants file for bankruptcy, but proposed legislation may change that in some jurisdictions. The California Senate recently introduced a bill that would prohibit property owners across the state from evicting businesses and nonprofits that can’t pay rent during the COVID-19 crisis. (Los Angeles and San Francisco have already done so.) But in addition, the bill would allow smaller firms who have seen revenue fall by 40 percent or more to renegotiate rent. If a deal isn’t struck in 30 days, the tenants can end the lease with no liability, including future rent, fees or other costs due. Industry groups say the bill would shift the burden of the crisis to property owners and could be unconstitutional.

Lenders Rising Up

In the midst of all of this, lenders are stepping up to proactively provide relief to owners in a number of ways, Wright noted. For example, a loan might contain funding obligations for additional capital improvements for a property, intended to increase cash flow and drive rents. Given the market uncertainty, a lender might be willing to reduce the funding obligation to mitigate risk and limit its exposure on the deal.

“The key is how long will the pandemic last, and at what point consumers feel satisfied that it’s safe to resume their normal activities,” Wright noted. “In a few months we’ll have more clarity about the long-term effects of COVID-19.”

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