NCREIF Panel Weighs the Impact of COVID-19 on Retail Assets
July 22, 2020
The coronavirus pandemic is wreaking havoc on the already beleaguered retail sector, with falling rent collections and a wave of bankruptcy filings by national and mom-and-pop tenants, according to a panel of experts at NCREIF's Virtual Summer Conference on July 16. On the upside, some sub-sectors are outperforming, and landlords have gotten creative in helping tenants navigate the crisis.
“We’ve been through downturns but never anything like COVID-19,” said Andrew Sabatini, SitusAMC Managing Director, Valuation Management, who moderated the panel. “We never imagined the U.S. and global economy could be brought to a screeching halt the way it has.”
Sub-Sector Variations in Collections
Collections among retail sub-sectors has varied widely since the pandemic hit, said Ryan Harms, Managing Director, Principal Real Estate Investors, which manages a large separate account for an institutional pension fund, with more than 50 retail assets across the U.S. From April through June, mall rent collections ranged from 15 to 30 percent; lifestyle centers from 25 to 45 percent; and power centers from 40 to 60 percent. “The best were community and neighborhood centers, where we had from 50 to 80 percent and certain centers producing 100 percent collections,” Harms noted.
Green Street Advisors is forecasting a decline in net operating income (NOI) of 13 percent for grocery-anchored and power centers, and 19 percent for malls. “On strip centers our main concern is around a few tenant types – restaurants, local businesses, fitness, theaters and highly levered retailers,” said Rob Filley, a Green Street analyst. “These tenants skew more toward grocery-anchored centers rather than power centers portfolios. So it may be a bit of a contrarian view, but we think power center NOI may hold up a little better than grocery-anchored centers.”
Enclosed malls bore the brunt of the damage, as many were forced to close during lockdowns. Green Street predicts half of all mall-based department stores will likely close over the next two years. But while anchor space comprises 50 percent of mall square footage, it makes up just 10 percent of NOI. “It’s not a huge hit to cash flows, but we are a little bit worried about co-tenancy clauses,” Filley said, referring to provisions that allow inline tenants to break leases or receive reduced rent if anchors go dark.
Of the roughly 1,000 U.S. malls, the top 250 graded A- or above make up 80 percent of value, Filley added. “So even though dying malls pop up in the headlines, when you invest in the overall mall landscape [through real estate investment trusts], the woes of B and C malls don’t have a huge impact on values.” Nevertheless, valuations have declined since the pandemic began. “We’ve moved values down 20 percent for malls and 15 percent for strip centers,” Filley said.
National Chain Fails and Omnichannel Wins
Coresight Research has estimated that up to 25,000 stores could close in 2020. Recent national bankruptcies include Nieman Marcus, JCPenney, J Crew, Pier One, GNC and Hair Cuttery. “While the lockdowns hit retail hard, many of the bankruptcies we’ve seen have been companies whose balance sheets were in a weak position going into the pandemic, and the loss of cash flow hastened the end,” said Daniel Radek, President of First Washington Realty, a national investment and management firm that owns 105 necessity and convenience-oriented retail centers in 22 states and Washington, D.C.
The fitness category, which wasn’t at risk before the pandemic, has been clobbered by social distancing mandates; both 24-Hour Fitness and Gold Gyms filed Chapter 11. Entertainment is also dicey. “I’m extremely concerned about department stores but I’m more concerned with theaters,” said Manuel Martin, who oversees Nuveen Real Estate’s U.S. retail sector platform. “We will have operators without clients because they are concerned about getting infected. They won’t have much cash to pay their rents and with film production [halted], they won’t have anything to show.”
Radek expects more retailers to fail over the next six to 12 months. “We have a lot of ‘dead men walking’ especially when you start to get into the smaller mom and pops and more effected industries like restaurants,” Radek said. “But for government grants and/or the balance sheet of their landlord, they’re not receiving cash flow, and they don’t have a balance sheet to fall back on. When the grace of those two handouts get turned off, they’re not going to be able to make it.”
On the bright side, omnichannel retailers are best positioned to survive. “Social distancing is going to erode all the margin of the retailers [so] the role of internet is going to be very important,” said Martin. Consumers are favoring local pick-up over delivery; pick up orders were up 81 percent in 2020 through mid-June but delivery rose just 33 percent. Other tenants are moving to drive through and mobile order only. Starbucks, for example, announced plans to build 300 pickup-only stores.
Forbearance, Transaction and Leasing Trends
As the impact of the pandemic became clear, owners moved quickly to offer rent relief. Radek said his firm negotiated three-month rent deferral agreements across the portfolio with large national retailers such as TJX, which have strong balance sheets but were forced to close amid lockdowns. “They waived co-tenancies and other issues that may be within the lease and then they pay us back over subsequent 12-month period of time,” he noted.
But the vast majority of forbearance requests came from mom-and-pop businesses. “It was a tenant-by-tenant analysis, but the goal was to use our balance sheet to help those tenants survive and get past this first wave,” Radek said. Early on, tenants were given information about the Paycheck Protection Program and other local resources. Those forced to shut down received 100 percent rent deferrals for several months.
Trading in retail assets has declined sharply, the panel noted. “The problem is you don’t have anything to underwrite,” said Martin. “Transactions are NOI based – and today the conditions are extremely averse to do this. We really need a normalized income stream to see where values are. There are some people trying to acquire preferred equity positions but it’s a difficult time to do any pricing discovery.”
Financing also remains challenging, Harms added. “Pre-COVID you could get financing for pretty much any retail sub-type, but there was such a [large] bid-ask spread, people just ended up refinance out, lowering their exposure that way and still getting strong yields,” Harms said. “Post-COVID there’s just not a market unless you have a really high-quality neighborhood center.” With few alternatives, some sellers will be motivated to dispose of assets, which could put pressure on values.
Radek said his firm has continued leasing, albeit at a slower velocity. Leases include creative language to give tenants comfort around the timing of their opening, built-in deferrals if the retailer is forced to close, and lower rents that gradually rise to market rate. Ryan’s firm is seeing more capital requests from tenants. “Rents are decently similar to pre-COVID with additional tenant improvement dollars,” he said. “In some cases, we are looking at becoming partners on some of those deals because you are basically financing the improvements, and we will see some upside if they are successful.”