In basic economic theory, when supply outpaces demand, it becomes a buyer’s market, because the seller needs to get rid of inventory to make a profit. That essential principle applies to real estate markets too, including those in which the key players are development corporations and owners that maintain malls, buildings, and other retail sites and the retailers that want access to those spaces.
During the COVID-19 pandemic, forced closures of nonessential businesses altered the appeal of different kinds of spaces for various types of retailers, while also creating a glut of closures and bankruptcies. For the actors who remain, the environment thus has changed, and both retail tenants and landlords are seeking to change their agreements to reflect those developments. The creative options take several forms.
In particular, many landlords are offering rent breaks, pauses, or reductions. If a business cannot operate at all, or its sales are down because shoppers prefer not to enter stores during the pandemic, it cannot keep up with a conventional rent payment. Rather than force them out, landlords are agreeing to accept lower base rates, sometimes half what the retail tenant had been paying. Whether the tenant ultimately will need to pay the accrued back rent varies; some landlords are saying they will take future installments, once the retailers are profitable again, while others anticipate writing off the gap as a loss.
Another option eliminates a base rent payment altogether, such that the landlord instead takes a percentage of any sales profits the retailer earns. This option has some appeal, in that as sales increase, so does the landlord’s income. However, if a retailer never really recovers, a percentage of its weak sales might not be enough to cover the landlord’s expenses.
One developer in Detroit offers a different incentive for retailers to keep working to remain operational: It promises them access to their security deposits if they use that money to renovate or reconfigure stores so that they can compete better in the pandemic era. For example, if a coffee shop wants to add more kitchen facilities, so that it can increase food revenues, the developer would help it do so by handing back the security investment that the existing tenant paid to move into the storefront in the first place.
Regarding existing uses, some landlords also are adjusting leases to allow for more pandemic-related flexibility. For example, many restaurants are opening more outdoor seating in previously restricted spaces, such as parking lots and sidewalks. Retailers of different formats also are seeking ways to support enhanced delivery or curbside pickup operations, which might require landlords to rescind or soften language in existing rental contracts that prohibited such efforts.
Some tenants also are requesting the addition of force majeure agreements (often known as “act of God” clauses, which state that when events outside anyone’s control, such as natural disasters, prevent two parties from completing a contract, no one is liable). Heated regulatory and legal arguments continue regarding whether the COVID-19 pandemic represents a force majeure, but regardless of the legal standard, landlords would prefer to avoid this designation. Instead, they might propose kick-out clauses, such that if a tenant does not reach some threshold level of sales, it can break the lease without further penalty.
Rather than just rents, another lease consideration involves the length. Shorter contracts can reduce the risk for tenants; even if they fail, they are not locked in to a multiyear rental contract. Although this option increases the amount of work for landlords, who would prefer to rely on guaranteed income from a steady tenant, it may be unavoidable in the uncertain, difficult pandemic era. Working harder to ensure some income is preferable to doing nothing and seeing empty retail locations that don’t provide income for anyone.
Discussion Questions:
- What are some of the different ways landlords are changing leases in the wake of the coronavirus?
- What other implications might a buyer’s market for retail locations have for retail tenants? For landlords?
Source: Esther Fung, “Retail Landlords Offer Pandemic Clauses in New Leases,” The Wall Street Journal, August 25, 2020