A Reimagined Retail Tenant-Landlord Relationship Can Bridge the COVID-19 Gap

A more collaborative relationship can help all parties find a mutually supportive path forward in an uncertain environment, says Cynthia Nelson of FTI Consulting.
Cynthia Nelson

The uncertain environment retailers and landlords are now occupying in the COVID-19 era requires a collaborative spirit in order to emerge healthier in the coming months ahead. A reimagined relationship can help both parties emerge intact from a slow recovery period.

Reevaluating tenants and rents

Shopping malls and certain classes of tenants are still being strongly impacted by the shutdown, on top of extant issues in the struggling retail industry, such as the rise of e-commerce and expanded competition that disrupt consumer buying habits and loyalty. With severely reduced foot traffic and indoor entertainment venues like movie theaters and arcades, as well as indoor dining, closed or operating at a substantially reduced occupancy, retailers’ recovery will be a continuing challenge for landlords.

Rent collections are improving—up from 25 percent at the beginning of the pandemic to around 60 percent today—but the tepid back-to-school season and curtailed family entertainment are hurting many malls. Given the amount of redevelopment and repositioning toward entertainment that had been taking place in malls, retail tenants are now struggling even more as a result of the pandemic, and with them, their landlords.

Of course, when tenants cannot pay rent, landlords cannot meet their debt service and pay operating expenses. This may require landlords to take a hard look at their tenants to evaluate those that will bounce back and attract consumers to create a more vibrant post-COVID-19 property versus those that will likely continue to struggle to survive. In other words, landlords need to look at which tenants to support with flexible rent considerations and those that will not be included in future plans.

A tripartite financial relationship

It is likely that although certain lenders have been somewhat accommodating about near-term debt service by providing deferments of payments, extended maturities or otherwise restructuring loans, landlords will ask for further relief through the end of the calendar year—and debt service will be a major concern in 2021. Rent considerations are affecting all parties involved, today and in the near future:

  • Additional concessions will be required as tenants will be asking for rent relief through 2020, with payback beginning no sooner than 2021.
  • Many landlords prefer rent deferrals over abatements as a short-term solution. However, they must seriously consider whether the retail tenant will be able to pay that deferred sum at some point—and when.
  • Rent relief puts landlords in a tight spot. On top of operating expenses, interest on debt still needs to be paid, and rent collections likely will not fully recover to rise to pre-COVID-19 levels for some time—although how long that will be is anyone’s guess.
  • Those landlords working with commercial mortgage-backed securities lenders may be in a better position over those working with life companies and other more traditional lenders because of the pooled nature of CMBS mortgages and special servicer structure.

Landlord-retailer considerations

Today’s financial realities are bringing several considerations to the foreground for landlords. Ultimately, they will need to decide which tenants will be viable in the future and are therefore worth working with through the pandemic, and when they need to simply “pull off the bandage” and evict those retailers who show little-to-no promise of survival.

No rent vs. empty space

Landlords must weigh the risk-benefit of having a tenant paying reduced or no rent versus having an empty space.

The matter of granting rent relief becomes further complicated if the tenant has multiple locations across a landlord’s portfolio; visibility into that establishment’s sales across locations—showing which may be performing more strongly than others—provides the landlord with leverage in terms of rent relief considerations. In this case, each party needs to understand its position and the reality of the situation—and the overall “health” of the portfolio—to arrive at a way to move forward together.

Bankruptcy

With major retailers nationwide declaring bankruptcy, landlords must also recognize that the option to seek bankruptcy protection is more conceivable for tenants than ever before, especially for retailers with many underperforming locations. Chapter 11 protection is a powerful tool for retailers to gain leverage with landlords in terms of their lease payments under a reorganization, which then greatly impacts owners’ cash flow.

For example, under §502(b)(6) of the Bankruptcy Code, the maximum claim a landlord can assert is the greater of one year’s rent or 15 percent of the outstanding obligation, not to exceed three years’ rent—which often amounts to a mere fraction of the total rent owed over the term of the lease. Therefore, landlords are well-advised to work with a good tenant that has potential to survive the pandemic downturn.

Rent structure

With less foot traffic and reduced store sales, retail tenants would prefer to pay a percentage rent right now, which likely would be less rent than the typical minimum rent due—a model many landlords had not embraced prior to the pandemic. However, they may be more inclined to consider this concession with a structured percentage-of-sales, with no rent or lower minimum rent as the economy improves. That way, the landlord participates with the tenant as more of a partner, with more at stake and incentive to help drive foot traffic to the location.

Co-tenancy clause waivers

Some landlords are asking tenants to waive co-tenancy and/or minimum occupancy clauses in the event certain anchor or other stores close, in exchange for rent concessions. In addition, lenders also may have covenants related to required anchor tenants, occupancy and allowed modifications to tenants’ leases that might need to be addressed to provide needed flexibility to landlords. Neither retailers nor their landlords want underperforming locations, and lenders don’t want to take back properties. It is therefore in all parties’ interests to communicate their situations to avoid triggering co-tenancy clauses and other covenants and the associated ensuing disputes.

Given the fluid retail landscape right now, it is hard to predict when business and consumer confidence will return to pre-COVID-19 levels. A more collaborative relationship between landlords and retail tenants—working as partners—and open communication about their needs and concerns (and landlords with lenders, as well), can help all parties find a mutually supportive path forward in an uncertain environment.


Cynthia Nelson is a senior managing director in the corporate finance segment at FTI Consulting. Contact her at Cynthia.Nelson@fticonsulting.com.

The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals. FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm.

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