The retailer-landlord relationship may be entering not just a new year, but a new era. After a contentious 2020, many store tenants and landlords are reshaping their leases based on lessons learned from the COVID-19 pandemic.
It's been a trial by fire. As stores were forced shut for several weeks early in the year, retailers were left with little to no sales to fund the costs of running their operations. Furloughs and layoffs mitigated labor costs, inventory adjustments mitigated supply chain costs and e-commerce helped.
But the rent was still due.
That led to disputes with landlords as many retailers delayed or reduced rent payments or refused to pay at all for the time that stores were closed. For their part, landlords struggled to respond. Some, with their own outstanding obligations, took their retail tenants to court, while others offered abatements of one kind or another.
The situation has left an indelible mark on both sides. Several retailers, in and out of bankruptcy, have taken steps to drastically reduce their physical footprints. Macy's, Gap Inc. and Francesca's, to name just three, are permanently closing hundreds of stores. In all, for 2020 until early December, the SNL U.S. REIT Retail Shopping Center Index's return was down 26.9% and the SNL U.S. Retail REIT Enclosed Malls Index's return was down 34.7%, which Wells Fargo analysts noted in emailed comments Dec. 10, both lag the broader commercial real estate industry.
"Retail REIT underperformance comes as no surprise as COVID-19 resulted in widespread shutdowns of non-essential retail, representing 58% of strip retail REIT portfolios and almost the entirety of mall portfolios," Wells Fargo Senior Analyst Tamara Fique said in the note. "The pandemic has been dubbed 'the great accelerator;' for retail, that has meant e-commerce taking a greater share of sales, store fleets being further rationalized, and retailer and retail REIT bankruptcies being pulled forward."
The new opportunity
With the pandemic still surging despite a vaccine and many consumers avoiding in-store shopping as a result, store-based sales remain muted. That leaves many of last year's challenges in place.
But tenants are taking lessons that will last beyond the pandemic. The power to some extent has shifted to retailers, with, as Wells Fargo's Fique says, "tenant retention key."
"Companies are working to retain tenants, particularly as there is a light at the end of the tunnel given promising vaccine news," Fique wrote. "As such, we anticipate ongoing rental assistance in the form of deferrals and abatements through at least Q1 2021, primarily for tenants that were strong pre-COVID. Occupancy levels are expected to decline, likely bottoming some time in H1 2021. Even as leasing activity picks back up, backfilling spaces will take time and capital."
The pandemic may have exacerbated existing issues for many retailers, which in some areas were paying relatively high rents even pre-pandemic, as traffic slowed and sales moved online, according to Bradley Tisdahl, CEO of commercial real estate advisory firm Tenant Risk Assessment, which works on behalf of landlords to evaluate tenant risk.
Early in the pandemic Tisdahl worked on a lot of rent deferrals and abatements. From that experience, many landlords and tenants have learned that an open conversation can behoove them both, Tisdahl and other experts say.
"This has been the year of landlords and tenants sort of compromising regardless of what the lease says, which is very, very interesting to watch, and, you know, it's been pretty successful," Jill Rowe, a partner at law firm Venable who represents real estate brokers, owners and commercial tenants, said by phone. "Not across the board, of course, and many tenants just had to go out of business because they couldn't afford anything under any compromise situation. But where it was possible to work out deals, people did, often without lawyers, sometimes with lawyers. I was kind of impressed to see people rise to the occasion."
The new lease
What comes next in the retail tenant-landlord relationship remains up in the air, but some trends are emerging, including a new level of flexibility on the part of both parties. Going forward, landlords will likely be dealing with better informed tenants.
In a recent report, real estate firm JLL describes a willingness to make tradeoffs that dismantle longstanding lease requirements. That includes tenants waiving clauses that would allow them to exit or alter their leases when a mall anchor leaves — a situation that has helped to empty malls as more department stores shut down.
Along with skirmishes over rent payments, some property owners and their retail or restaurant tenants last year also fought over whether a pandemic triggers a lease's "force majeure" clause, and whether that in turn absolved tenants of rent. (A force majeure, a French phrase meaning "major force," is an exceptional and unforeseen circumstance that is beyond the control of either the landlord or tenant, and that prevents them from meeting their obligations under their lease.)
In 2020, the system wasn't set up for a situation that pitted retailers against their landlords, according to Nick Egelanian, president of retail development firm SiteWorks.
"One of the changes that is sure to occur in the future is that tenants will demand that pandemics be included in force majeure clauses in their leases, and landlords will need to insure over that risk," Egelanian said by email. "It may end up like flood insurance with only the federal government able to underwrite the risk, but it would prevent a systemic collapse like we are seeing now. It would be far preferable for the government to install such a system now to better target aid to industries and sectors most affected by the pandemic — this would also greatly reduce systemic failure if properly administered."
Many force majeure clauses were quite "landlord friendly," according to Rowe, and that has led many retailers to more closely scrutinize their leases and better understand them. Many landlords are also being more flexible on other details, like lease terms, she said.
"We're still figuring it out," she said of what the new normal may be. "There are some leases being signed — some tenants are asking for very long leases and some are asking for short leases, it's very tenant-specific, and most are asking for one or the other," she said. "It's just much less uniform and interesting. Right now the tenants do have kind of the upper hand in most cases" when it comes to certain items.
Percentage rent, which used to be more common in retail leases decades ago, may be making a comeback thanks to the pandemic, according to JLL and other sources. In such leases, a retailer pays a base rent, plus a percentage of their revenue (say between 5% and 8%).
Using revenue to figure out the rent requires a retailer to share more details about its operations with its landlord, as when a business goes to a bank for a loan, according to Kenneth Lamy, CEO of financial management firm Lamy Group, who like Tisdahl works on behalf of landlords. That is already happening, and is fostering a sense of partnership rather than antagonism, according to people who work with both sides.
"Transparency has gone up — companies under pressure have been very open, sharing their financials and the challenge that they face," Tisdahl said. "I think it's very different than what it was a couple of years ago when they were just sending their checks. This doesn't seem like a situation to me that everything resets and we're back to run-of-the-mill leasing."