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What happens to Main Street when even the biggest retailers can't pay rent?

With billions of dollars in lost payments at stake, retail landlords have been working aggressively to find some resolution with struggling tenants.
An AMC Entertainment Holdings Inc. Location Ahead Of Earnings Figures
Landlords and lenders are willing to work with quality tenants struggling to pay their rent, but some companies don't even know whether they will survive the next six months.Patrick T. Fallon / Bloomberg via Getty Images

From Gap to Staples to Burlington Stores, retailers large and small have stopped paying rent amid the coronavirus pandemic. With April and May rent already past due, industry watchers worry that a glut of vacant storefronts is on the horizon — or even a commercial mortgage crisis.

The Cheesecake Factory, Subway, Dave & Buster's and AMC Theaters are also among the household names that have closed doors and suspended rent payments as mall shoppers and moviegoers stay home to curb the spread of the coronavirus.

Gap Inc., which owns Old Navy and Banana Republic, told investors last month that it has suspended its $115 million monthly rent payments as it considers how it will modify its lease terms or close stores.

"If we are unable to renegotiate the leases and continue to suspend rent payments, the landlords under a majority of the leases for our stores in the United States could allege that we are in default," the company said in a statement.

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Even with some malls opening back up after weeks of lockdown, 20 or so states remain shuttered. No shoppers means no sales and no revenue with which to pay rent. That means landlords don't have the money to come up with mortgage payments they owe their banks. It creates a giant domino effect all the way down the obligation chain, ending with big banks that hold about $3 trillion in commercial real estate debt, according to real estate lawyers and advisers.

"I'm concerned, and I've been concerned for six weeks," said Steven Soutendijk, a managing director with Cushman & Wakefield Retail Services. "There are going to be a lot of restaurants and small businesses that don't come back and figure out a way to make restrictions work."

Retail landlords collected an average of only 20 percent to 40 percent of the total amount owed in April, according to CBRE, a commercial real estate firm. That amounts to a loss of $4.1 billion to $8.2 billion in payments, according to data from CoStar Group, a commercial property industry analytics company.

Capital One and Ally Financial are among the 13 major banks whose credit ratings were just downgraded to negative by S&P Global Ratings because of the large tranches of commercial real estate and consumer loans they hold.

"Whether borrowers are ultimately able to meet the terms of the loans ... will depend on the duration of the pandemic."

"Banks already have been sharply increasing their allowances for loan losses, extending deferrals and making other accommodations to borrowers," S&P said in a news release. "Whether borrowers are ultimately able to meet the terms of the loans once the period of accommodation ends will depend on the duration of the pandemic and how quickly the economy rebounds."

With billions of dollars in lost payments at stake, retail landlords have been working aggressively over the last several weeks to find some resolution with struggling tenants. Some landlords are taking a percentage of the rent but asking tenants to pay it back over a few months or a year, according to advisers representing landlords and tenants. Others are applying tenants' security deposits to the rent due the following month, while some are tacking the balance on to the end of the lease.

"Everybody who is touching the retail rental stream is having to make some modification or deal in order to survive," said Eric Greenberg, a real estate partner at the Seyfarth law firm.

Some landlords are asking tenants to show financial information about their sales figures to prove they need rent relief before they consider rent abatements. Others are asking tenants to apply for government relief programs, such as the Small Business Administration's Paycheck Protection Program, to cover lease payments.

"Everything is on the table," said Michael Flood, senior vice president of commercial real estate policy for the Mortgage Bankers Association.

In April, the Federal Reserve stepped in to support lenders by reviving a financial crisis-era tool called the Term Asset-Backed Securities Loan Facility and extending it to include commercial rent. But that can go only so far as the pandemic accelerates the fall of retailers who came into the health crisis with loads of debt, little cash and business models that are increasingly irrelevant.

"Mortgage servicers are willing to work with well-capitalized landlords and quality tenants," said Naveen Jaggi, president of retail advisory services for the commercial real estate services company JLL. "They're looking at whether the tenant will last five years. But what if the tenant doesn't survive five to six months from now?"

Distressed companies such as JCPenney, Sears and Neiman Marcus are already in a challenging position to negotiate favorable rent abatements — and some retailers, including J.Crew and True Religion, have had to file for bankruptcy production as a result of the pandemic. The trend is expected to continue. The U.S. retailer default rate is estimated to surge from 4.7 percent today to about 14.4 percent in March 2021, according to Moody's.

When a retailer goes into bankruptcy or defaults on its lease payments, it leaves few options for landlords and lenders outside of foreclosure. In that case, the bank takes over the empty property and is responsible for selling it or finding a new tenant. But with few buyers on the market for an empty department store, selling will prove to be difficult once the virus is contained, according to commercial real estate analysts.

"I think people are realizing these are short-term solutions for what is a longer-term problem right now," Greenberg said.

Thomas Barrack, CEO of the real estate fund manager Colony Capital, warned of a "second crisis" in the form of a "potential blockage" in the commercial mortgage market as stable businesses no longer generate cash flow.

"Absent immediate intervention, the effect of the COVID-19 pandemic on the entire real estate market, particularly property values, could dwarf the impacts of the Great Depression," Barrack said.

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Small retail businesses have been hit hard. When the virus hit, Dawn Paige was on the verge of launching a retail store called Vanity's Gifts in downtown Durham, North Carolina. The store's suppliers in China are just now ramping up business. But even if Paige were to get inventory into the store, she still wouldn't be able to pay rent. She told her landlord that the store wouldn't be opening.

"It's just sad," she said. "This is invested from retirement savings, and that's just up in smoke."

What will distinguish who survives the pandemic and who may crumble comes down to companies' balance sheets and cash reserves, said Soutendijk, of Cushman & Wakefield.

"It's like, 'Who saved for a rainy day?'" he said. "Now it's raining, and whoever has an umbrella is going to be OK, and everyone else who doesn't is going to get drenched."