When Sales At Struggling Chains Fall Faster Then Commercial Rents (#GotRecession?)
Barneys’ fight with landlord is an extreme example of an issue bedeviling many retailers: high rents. When Sales At Struggling Chains Fall Faster Then Commercial Rents (#GotRecession?)
Don’t blame all the vacant stores on e-commerce. Sky-high rents are squeezing retailers, too.
Although commercial retail rents are down from recent peaks, they haven’t fallen as fast as sales at struggling chains. The rents remain higher than prerecession levels in many prime shopping areas such as Manhattan, Los Angeles and Dallas.
In a high-profile example of this tug of war, Barneys New York Inc. has hired restructuring advisers and is considering several options including a possible bankruptcy filing, as it seeks to renegotiate the lease on its Madison Avenue flagship and other locations, according to a person familiar with the situation.
The landlord raised the annual rent on the Madison Avenue store earlier this year to $27.9 million, from $16.2 million, this person said. Barneys fought the rent increase but lost during an arbitration proceeding. Reuters earlier reported that Barneys had hired restructuring advisers.
The retailer also is looking at whether it makes sense to reduce the size of the 260,000-square-foot store, and it is reaching out to potential investors who might be willing to inject cash into the company, the person said. Hedge-fund manager Richard Perry owns the majority of Barneys with a roughly 70% stake.
“Compared to a decade ago, rents are still up considerably—and for some retailers, it’s too much,” said Nicole LaRusso, director of research and analysis at CBRE Group Inc., a commercial real-estate company.
Landlords say it isn’t that simple. They argue retailers fueled demand with a flood of store openings coming out of the 2008 recession. And even when the landlords dangle lower rents, it is hard to tempt retailers to open stores when they are retrenching.
“We’ve cut rents by 30% and are offering all sorts of concessions, but we still have vacant space,” said William Friedland, a principal with Friedland Properties, which owns commercial real estate in Manhattan.
In other cases, though, landlords have an incentive to leave space vacant because slashing rents would violate their loan agreements, industry executives said. Moreover, any devaluation of the property would make it harder for them to borrow in the future.
“For these landlords, maintaining the valuation on their properties is more important than collecting an immediate rental stream,” said Richard Johnson, a partner in Odyssey Retail Advisors, a consulting firm that works with retailers and landlords. “It’s a waiting game, and many landlords would rather wait it out, hoping the market improves.”
Commercial rents in San Francisco are up 53% from a decade ago, and in Miami they are 46% higher, according to CBRE. Even in smaller cities, such as Nashville and San Jose, Calif., rents are up by nearly one-third.
In Manhattan, the average annual rent more than doubled from the beginning of 2010 to the end of 2014, peaking at $1,111 a square foot, according to CBRE, as Amazon.com Inc. and other e-commerce players were changing traditional shopping habits.
Some chains wound up paying as much as 30% of their sales in rent, double the historic norm, industry executives said. “At that point you are on your deathbed,” said Nina Kampler, a consultant who works with retailers looking to reduce their store base.
What followed was a record number of retail bankruptcies and store closures as the shift to online shopping depressed store traffic, which made the higher rents even harder to absorb. Retailers such as Ralph Lauren Corp. , Macy’s Inc. and Abercrombie & Fitch Co. exited pricey flagships and reduced the size of other locations.
Even though Manhattan rents have fallen by one-third from their peak, they are still well above their prerecession levels, according to CBRE and Cushman & Wakefield Inc., another commercial real-estate company. In parts of the city such as Madison Avenue, availability rates—a proxy for vacancies that includes both occupied and unoccupied space offered for rent—have hit 30%.
“It’s a huge challenge to negotiate renewals,” said Alyssa Gates, director of U.S. real estate for cosmetics retailer Lush, speaking about the country as a whole, not just Manhattan. “Landlords aren’t willing to go backwards in terms of rent. They are hoping the business comes back.”
Don Ghermezian, president of the American Dream retail and entertainment complex in East Rutherford, N.J., which is scheduled to open in October, said landlords are making a mistake if they raise rents without figuring out a way to draw more traffic to stores.
“If you’re going to be a traditional mall and just continue to raise rents, that’s not going to work,” Mr. Ghermezian said. Barneys has signed a lease for the new center and will offer cryotherapy as well as a boutique that sells cannabis-related products.
Barneys, which is much smaller than rivals Saks Fifth Avenue and Neiman Marcus, operates 13 department stores and nine warehouse stores. Industry executives say its spat with its Madison Avenue landlord, Ashkenazy Acquisition Corp., is a high-stakes game of chicken. Both sides have much to lose.
For Barneys, finding new space would be expensive and time-consuming, according to people familiar with the situation. The flagship store does about $300 million in annual sales, the people said.
Likewise, Ashkenazy would have trouble filling the space with a single tenant. The real-estate firm, which also owns retail space in Washington’s Union Station and Boston’s Faneuil Hall, didn’t respond to requests for comment.
“There aren’t a lot of other retailers of similar size that have that prestige,” said Andrew Goldberg, CBRE’s vice chairman.
If Barneys chooses to restructure its lease under court protection, it would be its second time filing for bankruptcy. Since emerging in 1999, it has changed hands several times. Mr. Perry, who was Barneys’ biggest lender, took control of the company in 2012, in a debt-for-equity swap. He is winding down his hedge fund.
Corporate Tenants Dump Excess Office Space, Sending Shivers Through the Market
They offered a record 42 million square feet in the second and third quarters.
More companies are looking to dump excess office space by renting it out to new tenants, flooding the market with additional supply that could depress U.S. office rents.
With many employees planning to keep working from home for the foreseeable future, big corporate tenants in city centers say they have a surplus of office space. Most of those companies are locked into long leases of as long as 20 years and have little opportunity to get out of these agreements.
That is leading companies from Airbnb Inc. and Twitter Inc. in San Francisco to Expedia Group in Austin, Texas, to try to unload their overflow by subletting unwanted office space.
Corporate tenants put a record 42 million square feet of space on the office market in the second and third quarters, according to data firm CoStar Group Inc. That increased the total sublease space in the U.S. to roughly 157 million square feet, or 1.7% of the total office inventory. It is the highest rate since CoStar began measuring it in 2005.
New reports of a vaccine trial proving better than expected at protecting people from Covid-19, the illness caused by the new coronavirus, helped unleash a huge Monday rally in office and other real-estate stocks, easing some of the most dire concerns for the sector.
But some still fear the overhang is likely going to get worse before it gets better, especially with the recent rise in Covid-19 cases and as more employers view work from home as an alternative even after the coronavirus pandemic comes under control.
The office market has held up much better this year than lodging or retail real estate. Hotel guests and conference organizers canceled trips and events after the pandemic hit. Many retail tenants have withheld rent. But most office tenants have been paying. Average office asking rents have barely fallen this year, according to Ian Anderson, senior research director of CBRE Group Inc.
Those metrics, however, mask how much supply is actually available after factoring in the tens of millions of square feet coming up for sublease. As more leases come up for renewal, the additional sublease supply is expected to pressure office rents, property analysts say.
It is made worse because corporate tenants are often more willing to offer their space at lower rents just to get some cash for it, said Jonathan Adelsberg, a partner and chair of the leasing department at law firm Herrick Feinstein LLP.
“There will be cases where tenants and landlords are going to be competing for the same business,” Mr. Adelsberg said.
The sublease discount historically has been around 20% below market rate, he added, “but given the plethora of space on the market today, we expect to see discounts greater than that.”
Office owners have largely made good on their debt payments during the pandemic. As of mid-October, only 2.5% of office mortgages that were converted into mortgage-backed securities were more than 30 days delinquent, said data firm Trepp LLC. That compares with rates of 14.3% for retail real estate and 19.4% for lodging.
But the office space starting to glut the market now could shave tens of billions of dollars of value off office buildings, creating big losses and the prospect of more defaults, analysts say.
“The heightened amount of sublease space suggests that tenants’ positions are more precarious than the vacancy rate would suggest right now,” said Nancy Muscatello, a CoStar senior analyst.
It isn’t unusual for businesses to put sublease space on the market during economic downturns. Companies typically contract or pull back from expansion plans only to resume their space consumption once recoveries begin.
Some brokers and landlords predict that office demand after the current recession and pandemic will follow a similar pattern. Douglas Linde, president of the big office owner Boston Properties Inc., said many tenants around San Francisco making office space available are in businesses such as retail and transportation that are “bearing the brunt” of the downturn.
“The bulk of sublease space is coming from the [Covid-19] recession and not a structural change in the way that people work,” he said.
But others say the current downturn looks different because of the mix of recession, pandemic, work-from-home and technological changes in the workplace. Businesses might be jettisoning space with no intention of leasing it back if they are adopting new workplace strategies.
The “unique factor” in this downturn is that “people are realizing that remote work is working better than they imagined and saying: ‘You know what? Let’s get rid of some of our space,’ ” said Mr. Anderson of CBRE.
Tech-heavy San Francisco has the largest sublease glut with 5.6% of its total office inventory available, according to CoStar. Austin, the Dallas-Fort Worth region and northern New Jersey across the river from Manhattan also had sublease surpluses of more than 2%.
Boston Properties owns office buildings in Boston, Los Angeles, San Francisco, Washington, D.C. and New York, including a 41-story Park Avenue tower where Maurice Greenberg’s C.V. Starr is putting close to 200,000 square feet of sublet space on the market. CV Starr is an insurance company with roots going back to a company formed in Shanghai. Mr. Greenberg formed American International Group in 1967 as a subsidiary of Starr.
Struggling Retailers Rack Up $52 Billion In Missed Rent
Eight months into the pandemic, clothing stores, restaurants, gyms and other businesses find themselves in a $52 billion hole.
That’s the total amount of retail rent that’s been missed since April, according to CoStar Group Inc. While some of the overhang has since been paid back, the remainder will be a drag on merchants as they try to rebuild and landlords demand their money. In some cases, the unpaid balances could drive them into bankruptcy.
“You’re going to have big bubbles that are going to be hitting next year or even in the fourth quarter,” said Andy Graiser, co-president of A&G Real Estate Partners, an advisory firm. “I’m not sure if they are going to be able to make those payments in addition to their existing rent.”
Overdue rent compounds the problems these companies have faced this year, including lost sales during shutdowns, consumers’ reluctance to return to stores and restaurants and the long-running migration of shoppers from brick-and-mortar locations to online venues.
Signet Jewelers Ltd., for one, deferred about $78 million of its rent payments, according to a September quarterly filing. In its most recent quarterly filing, Bed Bath & Beyond Inc. said it’s held back $50.6 million in rent payments and is in negotiations with landlords, while Francesca’s Holdings Corp. has said it owed $14.6 million in deferred rents and related costs as of Aug. 1.
The women’s clothing chain has since said it plans to shutter about 140 locations by the end of January and that it’s in danger of financial collapse.
Red Robin Gourmet Burgers Inc., meanwhile, said that it’s received default notices from some landlords after it stopped making full payments in April. Chief Financial Officer Lynn Schweinfurth told investors on a Nov. 5 call that the restaurant chain had negotiated amendments for about half of its leases by the end of its third quarter and continues in talks for the rest.
Many of these unpaid bills won’t go away, but are instead being pushed into next year. Signet said it plans to pay back its overdue rent by the middle of next year, while Francesca’s plans to repay the amount over the course of next year, it said in a quarterly filing in September, and is asking landlords for more concessions.
Representatives for Bed Bath and Beyond, Francesca’s and Red Robin didn’t immediately respond to requests for comment. A representative for Signet didn’t have a comment beyond recent filings.
CoStar estimated missed retail rent, including payments from store chains, restaurants, gyms and bars, in each month using its own data, industry statistics and landlords’ public reporting. The figures don’t account for any back rent that may have been repaid in subsequent months. In all, retailers paid $146 billion in rent from April to November, CoStar said.
By Graiser’s tally, the group broadly owes an average of two to four months’ rent from earlier this year, but he expects making good on those debts will be hard because sales probably won’t return to what he considers normal levels next year.
TIAA Real Estate Account, run by the giant Teachers Insurance and Annuity Association of America, said in a Nov. 10 filing it received more than 1,000 requests from tenants for rent relief, primarily among retailers, with most asking for deferrals of less than six months.
So far, the amount of rent collected from retailers climbed from 54% at the end of April to 86% this month, according to CoStar. Malls have fared worse, with only 79% of rent due this month received. That makes the situation critical for landlords, too.
“It’s going to take a period of years, not months, to get through this,” said Michael Hirschfeld, vice chairman at JLL, a real-estate services firm.
Deferred rents and a raft of tenants’ failures helped drive CBL & Associates Properties Inc. and Pennsylvania Real Estate Investment Trust into bankruptcy earlier this month. CBL said this week that it has made agreements with most top tenants and is seeing significant improvement in collections as these tenants pay past due rents.
In high quality malls, collections are improving, though still down. Mall giant Simon Property Group Inc. collected 85% of rents in the third quarter, up from about 72% in the previous quarter. Brookfield Property Partners LP said it collected about 75% of rent due from mall tenants during that same period.
Landlords — and lenders — may be willing to make more accommodations out of court now that there is promising vaccine news, said Jay Indyke, a lawyer who chairs Cooley LLP’s restructuring practice. With a return to normal now in sight, lenders may find it worthwhile to keep supporting retailers instead of letting them liquidate.
“There are certainly some players that are willing to at least convert some of their debt to equity,” Indyke said.
In the meantime, retailers are giving up rights to landlords in exchange for big rent reductions, such as granting landlords the ability to terminate their leases with 90 days’ notice. At the same time, retailers who saw strong online sales in recent months may decide they don’t need all the stores or markets they once wanted. “The conversations that retailers are having about their go-forward fleet is very different than pre-virus,” Graiser said.
U.S. Shoppers Pull Back At Start Of Holiday Season
Retail sales fell 1.1% in November amid surge in coronavirus infections, new business restrictions.
The holiday shopping season got off to a muted start as U.S. consumers reined in November spending amid a surge in coronavirus infections and new business restrictions in some states.
U.S. retail sales, a measure of purchases at stores, restaurants and online, dropped a seasonally adjusted 1.1% in November from the prior month, the Commerce Department said Wednesday.
October sales were revised to a decline of 0.1% from an earlier estimate of a 0.3% increase. Sales were up by 4.1% in November when compared with the same month a year ago.
Restaurants, department stores and vehicle dealerships all reported sharp sales declines in November, with clothing and furniture purchases falling. Purchases of groceries and building materials increased, along with online sales.
The November and October drops marked the end of several months of growth in retail spending after sharp declines earlier this year when the coronavirus pandemic triggered widespread business closures.
“Anywhere there’s crowds people stayed away from,” said Joshua Shapiro, chief U.S. economist at consulting firm Maria Fiorini Ramirez Inc. “It underscores the difficulty here till the vaccine is widely distributed,” he said.
The retail sales report and other readings on the U.S. economy suggest the recovery is slowing after a burst of growth over the summer.
Hiring growth eased in November while worker filings for unemployment benefits recently increased. Surveys of factories and service-industry companies released on Wednesday separately showed U.S. output grew at a solid pace in early December, but at the weakest pace in about three months.
U.S. home-builder confidence fell in December from an all-time high, breaking a seven-month streak of gains, according to a measure from the National Association of Home Builders released Wednesday.
Lawmakers in Congress were close to a $900 billion deal on Wednesday to provide a fresh round of economic stimulus that was expected to include enhanced unemployment insurance and another round of direct payments to households, according to people familiar with the negotiations.
The Federal Reserve, meanwhile, on Wednesday updated its plans for purchases of government debt to support the economy and said it expected interest rates would remain near zero through at least 2023, as the labor market and economy rebound from the pandemic.
Fed Chairman Jerome Powell said he and private forecasters expect the surge in virus infections to slow the economy through the winter, with growth picking up as more people are vaccinated next year. “The economy should be performing strongly” by the second half of 2021, he said.
“We’ve got to be braced for a period of two, three, four months of extreme vulnerability for the economy,” James Knightley, an economist at ING Financial Markets LLC, said. Mr. Knightley expects gross domestic product to contract about 1.2% in the first quarter of 2021 after increasing around 1.5% to 2% in the fourth quarter. Mr. Knightley said he “can’t see containment measures wound down meaningfully until vaccination is at a critical mass.”
“We’ve got to be braced for a period of two, three, four months of extreme vulnerability for the economy.’
— James Knightley, economist at ING Financial Markets LLC
U.S. shoppers spent less than last year over a five-day stretch including Black Friday and Cyber Monday as increased online shopping was offset by fewer people visiting physical stores during the pandemic.
People spent an average of just under $312 on holiday-related purchases from Thanksgiving to Cyber Monday, down 14% from 2019 though on par with 2018, according to a survey by the National Retail Federation and Prosper Insights & Analytics.
Retailers also pushed an earlier start to the holiday season, both to limit crowds at stores and to ease pressure on supply chains by avoiding preholiday order bottlenecks.
The National Retail Federation, a trade group, on Wednesday said it continues to expect holiday sales will increase at least 3.6% with at least 20% growth for online shopping.
Other data show that spending has continued to lag since the Thanksgiving holiday. JPMorgan Chase & Co.’s tracker of 30 million credit and debit cardholders recorded a 3.5% decline in spending from a year earlier in the week through Dec. 12.
Credit- and debit-card data collected by research firm Affinity Solutions and research group Opportunity Insights showed that overall spending was down 1.7% in the week ended Dec. 6 compared with January levels.
Anthony Dukes, professor of marketing at the University of Southern California Marshall School of Business, expects retailers to suffer as the country faces the latest wave of coronavirus infections, and “more shakeouts of smaller businesses and dinosaur department stores will continue.”
He said demand should pick up in the spring as vaccinations lead to an easing of social-distancing measures. “Once we can do what we can do, people will be glad to get out,” Mr. Dukes said.
Retailers with significant online sales, particularly those with products catering to consumers working from home, have performed better than businesses that rely on in-person interaction.
Lululemon Athletica Inc. last week reported a jump in sales and profit in the most recent quarter, as pandemic-weary shoppers snapped up its athletic apparel and other comfortable clothing, though it offered a less rosy outlook as Covid-19 surged.
Carlo Castronovo, owner of Giusseppe’s Pizza & Italian Cuisine in Old Bridge, N.J., said the pandemic means “business is lower than it’s ever been but we’re staying afloat,” as curbside pickup and home delivery have been “a savior for sure.”
“It’s tough, mainly because everyone’s nervous,” said Mr. Castronovo. Normally at this time of year the restaurant would be catering holiday parties, “five trays of this and six trays of that—that’s definitely ended,” he said.
Essential businesses have fared better. Costco Wholesale Corp. reported strong quarterly sales last week as homebound consumers spent more on food, home goods and fitness products during the pandemic.
More people eating breakfast at home during the pandemic has helped drive orders for Hidden Springs Maple in Putney, Vt.
The family-owned maple-syrup processor has seen a 34% increase in sales across the board since March, with sales from its website up 74% and Amazon.com Inc. orders up over 130%. It closed its retail store due to the pandemic, and repurposed the space for shipping orders.
“It’s been quite the crazy ride, who knows if it will continue next year, it depends how elastic people are with shopping online,” said its manager, Andrew Cooper-Ellis. This year the company canceled its usual Black Friday promotional event just to try to keep up with demand, he said.
Commercial Real Estate’s Pandemic Pain Is Only Just Beginning
The coronavirus pandemic shuttered thousands of U.S. restaurants, gyms and stores, kept office workers at home and left hotel rooms sitting empty. Yet, so far, the commercial real estate market hasn’t really had a reckoning.
That’s set to change.
Lenders have granted struggling building owners months of forbearance, avoiding fire sales. But even as vaccines herald the slow return to normal life, it’s increasingly clear the fundamentals of real estate have been altered.
Next year, many property owners who’ve fallen behind on debt are going to have to put more money into their buildings, sell at distressed prices or hand the keys back to the bank. Roughly $430 billion in commercial and multifamily real estate debt matures in 2021, forcing lenders and borrowers to come to terms about what buildings are worth in a world the pandemic reshaped.
“That period of ‘let’s just put a Band-Aid on it’ is more or less coming to a conclusion,” says Wendy Silverstein, a former executive with Vornado Realty Trust and WeWork who recently started a restructuring and advisory firm. “There’s a lot of collateral damage that’s going to be hanging around for a while.”
That damage has the potential to ripple far beyond building owners and their tenants. Commercial property underpins the tax base in many cities across the U.S., and a downturn could pummel local budgets. As loan losses mount, the slump could also put stress on the banking system. The Federal Reserve singled out commercial real estate in its most recent Financial Stability Report as showing particular signs of weakness.
Projections from real estate services firm CBRE Group Inc. suggest that property values for apartments, offices and retail real estate won’t find their bottom until the middle of next year.
Worse, the rebound to pre-Covid levels could take until 2022 or beyond. One exception to the trend: industrial real estate, the warehouses and logistics centers that have gained value as investors snapped up buildings essential to the delivery economy.
Unlike the last property market downturn, which was caused by excesses and exuberance in the financial markets, Covid-19 has upset real estate fundamentals by changing how we lead our lives.
Travel will be slow to come back, leaving millions of hotel rooms empty. Companies are already deciding they’ll need less office space than before, either because of staff cutbacks or because more of their employees will permanently work from home. And the rise of e-commerce—along with small business closures—will create a glut of retail space in a country that already had too much of it.
By one measure, about a billion hotel room nights will go unsold this year. Foot traffic on Black Friday, the traditional start of the holiday shopping season, plunged more than 70% at shopping malls as consumers bought Christmas gifts online, according to S&P Global. More than 100,000 restaurants are closed permanently or long-term.
“Retail will remain just a mess, hospitality will have a very challenging year, and, in more isolated instances, office will be problematic,” says Dave Bragg, a managing director at real estate research firm Green Street.
The most glaring distress is in the $529 billion market for bonds backed by commercial real estate loans. The delinquency rate last month for commercial mortgage-backed securities (CMBS) was 20% for hotels and 14% for retail, according to Trepp. Those obligations that will become more difficult to repay as they fall further behind.
To a large extent, real estate has always been about location. And, if nothing else, the pandemic has reshaped where people want to live, work and shop. The Atlanta Fed recently began tracking fundamentals for apartments, offices, retail and industrial real estate in metro areas across the U.S., creating an index of whether they’re trending in a positive or negative direction.
As remote work has enabled people to leave high-cost areas like New York and San Francisco, for instance, their apartment markets have started to show the telltale signs of stress: rising vacancies and falling rents. More affordable places like Dallas and Indianapolis are holding up better.
Apartment Market’s Winners And Losers
Atlanta Fed’s momentum index shows rental housing under stress in some pricey metros and holding up in many affordable ones, as of Sept. 2020.
Office owners in many high-cost areas are going to have to contend with higher vacancies as companies plan for a future where remote work is far more common. Deutsche Bank AG is weighing a plan where employees would spend two days a week at home, while Facebook Inc. has said that half of its workforce could be remote in the next decade.
Others are considering shifting where their workforces will be. Goldman Sachs Group Inc., for instance, has scouted for offices in South Florida in a potential relocation of part of its asset-management business from Wall Street. Silicon Valley stalwarts Oracle Corp. and Hewlett Packard Enterprise Co. are moving their headquarters to Texas.
For now, office use is still just a fraction of what it once was. But it’s faring better in car-dependent cities like Los Angeles and Dallas than in places where people are more likely to ride public transportation, such as San Francisco and New York.
Percent Occupancy In Offices
Office workers are still largely staying home, though rate varies by city.
Even borrowers who are current on their payments may face challenges when their debt matures and they need to refinance or pay off their principal. Financial restructuring has already begun, mostly behind the scenes.
“Now what you’re seeing is somebody has to write a check,” says John Murray, head of commercial real estate at Pacific Investment Management Co. “The timeout is over.”
The new lifelines come with stricter terms, often in the form of preferred equity or principal payments to reduce the loan-to-value ratio, he says.
Loans Coming Due
More than $2 trillion in commercial real estate debt matures through 2025.
Even as an onslaught of distressed debt looms, there’s plenty of capital to chase deals. Private real estate debt funds raised $10.7 billion in the third quarter, the most of any strategy, according to Preqin, while North American real estate funds for all types of investment were sitting on almost $200 billion in dry powder in December.
All that money may limit how far commercial real estate prices fall. Congress’s new Covid relief agreement, which allows banks and other lenders until the end of next year to work with delinquent borrowers, also could give businesses more time to stay afloat. And by mid-2021, widespread vaccinations may allow consumers to finally escape from home and return with open wallets to hotels and malls. As Richard Barkham, chief economist for CBRE, put it: “We’re entering the dark before the dawn.”
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