The numbers are not in yet for May but it is pretty safe to say that rent payments by tenants, especially in the retail world, and then secondarily in apartments, will ratchet downward substantially.
April was really a test case, and somewhat early in the massive and quick shutdown of the economy, and the State of Oregon’s edicts to basically “Stay at Home”, which basically shuttered most retail businesses in fitness, health, malls, services and most directly to our predominate and important food and beverage establishments.
Office and business park spaces have been reduced to a large degree as office and flex tenants have reduced staff or are working remotely. But there are also lots of stories of many businesses operating generally “normally”. This has, in the ensuing weeks, led to many small to medium businesses making painful decision to let go, or furlough many of their employees to reduce expenses and try to “weather the storm”. Notoriously under-capitalized with little or no financial resources, many smaller retailers and restaurants were unable to make April rent payments to their landlords, but many were able to scrape enough together to make good on all or part of their April rent, with many thinking and hoping this may be a temporary downturn.
May and June will be much different story with predictions that a majority of local smaller, and even medium-size regional retail tenants not being able to pay anything. This is not immune to smaller local businesses as dozens of huge national firms like the Gap, Williams of Sonoma, Subway, 24 Hour Fitness, and many more that are paying no, or reduced, rent.
The larger mall and shopping center space was in many locations on a slow decline over the last decade due to explosion in e-commerce and changing demographics that frowned on these shopping environments. Coronavirus will only hasten this trend and will provide a more quick euthanasia or further closures for many wounded prior retailers.
While apartment rent payments took a slight hit to April payments, with anywhere from 8-15% of non-payment, many landlords are bracing for something in the range of 25% of their apartment renters not paying rent in May and June.
As one large apartment developer owner related, “It is all over the map with our projects, with one project having little or no non-payments and with another that was close to 20%. It is hard to figure where it will be in May, and further this summer, as many of the tenants are now unemployed or underemployed with no real chance of any positive change until fall or longer. It is definitely uncharted territory.”
The office sector and those tenants are the big unknown right now. There is very little data or even anecdotal information on office tenants, which are far less dependent on locating and peer-to-peer interactions, and are remotely working. But it is safe to say that negative effects are coming to many office users as the economic repercussions begin to ripple into design, service, branding, digital, sportswear, advertising, non-profit, construction, certain tech sectors, and other office-oriented industries, many of which are big users in Portland. There are multiple surveys and commercial real estate soothsayers saying there will be a systematic decline in office space demand and usage as the economy worsens over the coming quarters (and years?) thus putting pressure on larger users of office space. The days of having dozens, if not hundreds, of people closely aggregated in an office are numbered, as the forced-upon remote working paradigm becomes more permanent and firms understand it can work well. This will take time to gain any sort of clarity or definition as to the mid and long term impacts, but many office users new to Portland or looking for more or different office spaces have “paused” or pulled back completely.
This does not bode well for Portland’s somewhat overbuilt office market that has big chunks of available space and another million square feet of space in the pipeline of new or “recycled” space in older buildings. Office landlords will be marginally immune to defaults and lessened rent payments in the short term… but changes are a coming. The big question no one can answer is how long and how deep the impacts. Call me in later this summer.
Landlords and Tenants are feverishly working in this new and changing commercial real estate market to come up with strategies with their most at-risk tenants encompassing rent reductions, deferments, delays or even forgiveness in the short term that undoubtedly will need to be revisited almost monthly going forward. This is no one size fits all sort of situation. Each tenant and their business is somewhat different, so many landlords are working overtime to tailor their agreements to each tenant’s type of business and capabilities. Let’s just say there are lots of lease amendments being written and executed.
For many tenants and landlords who are looking out into summer and the end of the year, it may be a relationship that is maybe unsustainable. As one tenant in a recent Oregonian article related, “While we appreciate our landlord working with us on our rent for the next couple of months, the revenue that has been lost to us is not something that we are going to get back for many months, or even a year or two. There will not be a switch that gets turned and we are back to January of this year. Additionally, the financial ability for us to rehire and replenish our inventory is very challenged.” This makes deferments to later in the year or down the road even more problematic and, while still early, there have been numerous announcements of permanent closures of restaurants and retailers, and there have been some prediction rumblings that as many as 40% of retailers, especially in the food and beverage sector, not making it through. Ouch!
Kurt Huffman, of the renowned restaurant group Chef Stable (Lardo, Grassa, St Jack and more), in the same Oregonian article related “I do not see how our group’s restaurants can return to any sort of profitability within the next year if even longer. It is impossible to predict the long term viability of restaurants, and people will be very cautious of going out and spending and being in gathered spaces even if we reduce seating capacity substantially to allow social distancing. 50% of our previous business is better, but really does not allow us to stay viable as our overhead and costs can’t really be adjusted to compensate for that big of a loss in business”
While Governor Brown issued an executive order April 1st placing a moratorium on all commercial evictions, it is somewhat of a moot point with many landlords, who have long term relationships their tenants and few, if any, options. She also recently gave some new restrictions on gradually opening up certain establishments, but the initial restrictions for many retailers, especially those in food and beverage, are too expensive and difficult to pay for or manage, to only get back a semblance of their business.
“I have many long term tenants that I know and really appreciate their business as we have worked together for years, and evicting or moving out a tenant especially one that is close, is emotionally and financially painful. Plus who the hell is going to step in and rent the space? Everyone is pretty much stuck for now,” a property owner (yes many like to remain anonymous) of multiple properties related. This becomes much more of a quagmire if a tenant and business elects to declare bankruptcy. Several attorneys weighed in about the situation in a recent Business Journal article, about how landlords and tenants should be in constant communication and employing flexibility far before the commercial eviction moratorium ends.
“Landlords will need to decide which tenants have the potential to make it and which might be better to cut losses and terminate leases. The ante has been upped and the stakes have increased, and without really good honest communication between landlords the problems can be exacerbated,” said attorney Joe Vobril.
Another attorney chimed in, “If you wait until later of the end of the 90 day moratorium to have these communications and a plan in place it will be trouble.” That trouble he refers to is the possibility of some tenants declaring bankruptcy, which puts a pause on debts owed, including lease obligations. With the courts potentially swamped with these actions, timelines of getting tenancies and their obligations resolved will be very extended, and of course limits the landlord’s options especially with their mortgage holders.
The PPP (Paycheck Payment Plan) does little to help as restrictions on those dollars mainly goes towards paying employees and does little for on-going small business expenses such as rent, inventory and other overhead expenses. While over a million businesses were able to access small business loans, the websites often crashed and, generally, resources were inadequate given the need as short-term estimates are that over 6-million businesses applied with more coming but availability of more dollars remains uncertain.
The other somewhat more troublesome aspect to this is on the mortgage side of the equation, where landlords with even low loan-to-value mortgages struggle to cover their payments, as tenants go into default and cannot pay their rents. This is especially problematic for smaller commercial property owners that depend on rents for income and have less financial cushion to dip into assets to pay monthly mortgages for long. I should also say that larger, more financially capable landlords, both locally and nationally, which often own multiple properties as protected separate LLCs, while more capable, will also not want to pay their mortgages as rent income falls and seeing the pain going out multiple quarters if not longer.
In talking with multiple local property owners with mortgages, they relate, like many aspects in this economic malady, that “it is all over the map”. Generally some of the local and regional banks have been communicative, flexible, and very willing to come up with individualized strategies to defer payments for the coming months. Often called “Forbearance”, it requires that principle and interest, and many times, added charges, required of the borrower, to forgo or reduce mortgage payments over a period of time.
“The local guys have generally been good, and really understand the gravity of the issues, and sincerely want to come up with strategies that can help. The larger national banks and insurance companies have been less flexible and slower in their response, in some cases real jerks, if you can even get to talk to anyone about your needs,” said a property owner with two dozen properties and multiple mortgages. He also related that one of his larger financing sources related that you need to pay your mortgage in April and May or you will be in a “grace period”, default, and in risk of foreclosure. Nice guys!
There are several local efforts on the part of property owners to band together to ask for local, state or even federal pressure for assistance to banks and commercial real estate mortgage holders to “work with” their borrowers as they see rental income plummet and seek to work with their tenants. One such effort is United Relief, which takes a cooperative approach of landlords and tenants to lobby aggressively for the same types of strategies for banks and mortgage holders that landlords are using to keep their tenants viable. There are legal obstacles to what, if any, power state or local officials can have on any sort of legislation forcing banks to alter their mortgage rights.
I talked with several local bankers and again they were “off the record”, but many have shut down new commercial lending for 60-90 days, and one even admitted they have “walked back” several loan commitments they made prior to the pandemic. Here is the general paraphrased comment: “We are continuing to work with some long-time, well qualified tenants on refinancing, but new loans are paused for the time being as we start to understand better the strength of the borrowers and the underlying real estate going forward. Net operating income, appraisals and valuations are just so much in flux right now, and it is not hard to say all of these aspects in the commercial lending market will take a hit with some product types, such as retail and hospitality, being in the most jeopardy, but very few property types will be immune. Additionally our bandwidth is being tested as many of our loan people are working on the asset and existing mortgage side to shore up those loans.”
On the other hand, I have also heard several banks, mostly local and regional, that are looking at deals and financing for “quality” real commercial real estate, albeit with more conservative LTV’s and higher debt coverage ratios, and, of course, scrutiny of tenants and potential operating incomes. But deals are getting done.
Nationally, the effects have come quick and pronounced with most agreeing that commercial mortgage problems will easily surpass those seen in the 2008 recession. Commercial Mortgage Bank Securities (CMBS) which are vehicles that take loans on all sorts of commercial properties (apartments, office buildings, shopping malls, et al) and package them into an investment product (which was posited as one of the main evils and causes of the previous recession), are usually the first to go as they really don’t have the flexibility to work through loans like banks, insurance companies and other lenders. They account for 20% of all commercial loans. Already a jump in non-payments of 10 fold have been recorded, with 20% of all hotel and lodging CMBS in a “grace period”. Retail is less, but not by much.
One positive is that most of the large traditional banks and insurance companies are much better capitalized going into this virus hurricane than they were in 2008, but even with record profits and substantial financial cushions, some of the largest banks are setting aside loan loss reserves into the tens of billions of dollars already, and most think these will need to be regularly added to as the extent of the issue becomes more quantifiable. Though the Federal Reserve is providing liquidity throughout the system by buying bonds and securities, cutting rates to zero (maybe going negative?) and potentially relaxing how banks need to set aside funds for bad loans, their tool box is getting lighter. It is in all financial institutions’ best interests to work with all their borrowers both corporately, and even more so in the commercial real mortgage market, because foreclosure on mortgages is painful, lengthy and costly, and, really, do they want control of these properties especially in certain hard hit sectors that will have huge valuation hits and the prospects of managing these properties back into shape very much diminished?
Another fear is that financing for even the most vetted and safe new developments and construction projects will be reconsidered or become more restrictive, which impacts the viability of the project when we need to keep these vital drivers of our economy (especially much-needed housing in many cities) going. It will take time to understand how the financing and mortgage industry will be impacted and react to these challenges
Feel free to email me with comments, viewpoints, information and questions.