COVID-19: The Fate of Real Estate

Article

Q&A with Mark Dufton, CEO of Real Estate

Date April 25, 2020

 

The economic impacts of the coronavirus will continue to increase in severity the longer local governments deem stay-at-home orders necessary as businesses whose doors remain closed continue to incur operating expenses like rent with little to no cash flow.  For over a hundred years, Gordon Brothers has helped clients navigate through change, including helping clients manage and assess their real estate.
 

Mark Dufton is the CEO of Gordon Brothers’ Real Estate division and brings more than 25 years of real estate and management experience to Gordon Brothers.  In his role as CEO, Mark leverages his broad industry expertise to guide the expansion of Gordon Brothers' core real estate businesses.  We asked Mark about the current COVID-19 related difficulties in the retail and commercial real estate markets as well as the industry’s future in a post-COVID-19 economy.
 

Q: What challenges are tenants facing right now?  For example, how should tenants go about managing lease payments or deferments?
 

The biggest issue is what to do about rent.  Initially, there was a lot of focus on closing down stores and dealing with employees.  Then, in mid-March it transitioned to how retailers deal with rent.  Generally, where a store is not open, a client is not paying rent.  Many of our clients sent letters to their landlords stating they would not pay rent in April and opened up discussions about future rent payments for the following few months.  It is becoming clear that this is going to be a three-month issue at a minimum, April, May, and June, as far as rent is concerned.  Some clients have already addressed that time period, informing landlords that they won’t be paying April, May, and June rent upfront.  A few tenants have taken it further and informed their landlords that they will not be paying rent at all during the months they were required by their state or local government to be closed. But, if there wasn’t a state mandate, they would pay the rent back over a 12 month period starting January 2021 in 12 equal installments.  This exhibits both ends of the spectrum.  Some of our clients have even been paying partial rent during this period, highlighting that there is a number of responses to the issue.
 

Q: What conversations are taking place between landlords and tenants in terms of current and future rent?  What are some of the more effective strategies you are seeing?  Will replacement tenants be a viable alternative for landlords moving forward?
 

For landlords, the public statements they have issued are quite firm, expecting tenants to pay rent or defer April rent only.  However, behind the scenes there has been much more cooperation from landlords, especially the larger landlords.  Most seem willing to address tenants’ concerns with varying options depending on their size, liquidity, volatility, location, etc., so landlords are being responsive.  In general, there hasn’t been a need or push for legal involvement because there aren’t many legal arguments or leases that account for this type of scenario.
 

Landlords are taking more of a wait and see attitude.  Of course landlords have commercial mortgages, so there are really three parties that need to cooperate to get things back up and running.  Generally, the industry really wants to move forward.  Naturally there will be some lawsuits and circumstances where agreements won’t work out, but it’s in the landlord’s best interest to keep occupancy high and as much rent coming in as possible.  It will more difficult and more time consuming to get replacement tenants into a space and at a similar rate.
 

Q: Do you expect retailers to get any form of rent or relief?  If so, in what form and how extensive do you think that relief will be throughout the U.S.
 

A few federal programs, including PPP, have helped and will continue to help smaller retailers and restaurants survive.  Programs like this have kept many afloat over this interim period, but how long these programs can and will last depends on how long retailers and restaurants stay closed.  Will it reduce the projected number of 10% of restaurants expected to remain closed indefinitely, once stay-at-home orders are lifted?  This is currently unknown, but it is certainly helping many tread water for the time being.
 

On the real estate side, I had imagined there would be more available in terms of relief for commercial and retail tenants by this point.  Most of the relief so far has come from the federal and state governments and have been in the form of protection for residential renters and some protection against the foreclosure of commercial tenants.  To date much of the focus has been on getting loans into the hands of small businesses.
 

Q: What would you recommend to retailers or commercial and industrial renters to help mitigate losses in the short term as well as help reestablishing themselves in the long term, when businesses are allowed to reopen?
 

I have been advising our clients that if they don’t have a store open, don’t pay rent.  But it is important to communicate the situation to their landlords and maintain professional courtesies.  Talking to them about April, May, and June rent and the available options is very important moving forward.  Its really the only way they can preserve their cash flow at this point.  Additionally, businesses should apply for any government programs that offer loans or relief if certain criteria is met.  They also should attempt to keep some cash flow through curbside pick-up or delivery if their business model makes that possible.
 

Q: What do you see the real estate sector looking like in Q4 and Q1 of 2021?
 

Restaurants and apparel retailers will be particularly hard hit.  Pre-COVID-19, there was a lot of growth in the fitness space, and that will likely continue.  It might take them a little longer to reopen and gain momentum, but this sector will likely continue to grow eventually.  I think there will be a fallout in the B and C mall sector.  Many were on the brink of failure before the pandemic, and now they have even more distressed tenants occupying their spaces.
 

Q: What do you think are the long-term effects of COVID-19 for real estate?  Are efforts needed to address larger sector trends that have been exacerbated by the outbreak.
 

The real estate industry associated with retail was right-sizing before the pandemic, and it will continue to do so in a post-COVID-19 world, most likely at an expedited rate.  It won’t be cataclysmic, but the industry will continue to right size.  We were over retailed on a square foot per person basis.  Combine that with internet sales continuing to dominate the retail space, and requirement for brick and mortar retail space reducing.  The pandemic will certainly hasten the readjustment, but retail will come back strong.  Apparel and restaurants will struggle initially, but they will eventually reach an equilibrium.