30 May Both sides lose in commercial real estate standoff
“It’s not the size of the dog in the fight, it’s the size of the fight in the dog” is one of those folksy aphorisms that sound clever on first hearing but tend to fall apart upon cursory analysis.
In a confrontation between, say, a Chihuahua and a Doberman, it’s possible for an upset to occur and that a much larger but fully pacifist pooch will be scared off by a feisty, yipping dog. But that’s not the outcome the track record would suggest.
Which sets the scene for a discussion of something for which dogs of all sizes have little use—commercial real estate.
The COVID-19 pandemic and the public-health measures implemented to combat its spread have hit some businesses directly, like restaurants and retailers ordered to close.
Then there are those businesses that catch the secondary impacts—like property owners and landlords.
Leases and rent tend to be one of the two biggest operating costs a business faces, along with labor. A restaurant or retailer with no revenue because it’s closed has no money to pay for either. The issue of labor expense can be resolved quickly if harshly; employees are let go.
The matter of real-estate expense is thornier to deal with. Businesses that don’t own the space in which they operate usually do so under long-term leases, five or 10 years being common terms. It’s not common for leases to be priced according to how much revenue the business is pulling in. The rent is due whether the business is struggling or thriving.
Property owners have responded to the unusual circumstances—a downturn that has hit broadly, deeply and incredibly fast—with a variety of action plans. A few, such as Vulcan Real Estate (the property development and management company of the late Paul Allen), have waived rent payments for some tenants. Others have offered reduced payments, or deferments of payments now owed until later. And some are holding the line—you signed the contract, we expect our payment.
As easy and tempting as it might be to think of property owners and landlords as all being the same (and all resembling Snidely Whiplash), they come in all sorts of financial shapes, sizes and conditions, from individuals and families eking out small incomes on a single building to giant real-estate investment companies (who, in a sense, are also relying on property income for retirement, only in this case the retirees are pension funds).
They too have bills to pay. Do you think the government, as hurting for cash as it is, is going to magnanimously say “We know you’re hurting. Take a quarter or two off from property taxes.” Buildings need a certain amount of maintenance no matter what their occupancy.
Tenants also span the spectrum from the smallest of small businesses to giant global corporations, and here’s where we make the connection to that old saying about dogs and fights.
Small businesses are the most likely to be sunk the fastest by lease obligations they can’t pay because they’re not allowed to be open, and they’re making considerable noise about it. They also happen to be the players with the least amount of leverage to push property owners into concessions. They don’t have big legal and real-estate departments—don’t have any such departments—that do nothing but negotiate and renegotiate leases.
The only option they have is to mimic a practice by some homeowners during the Great Recession: “key-mail,” in which the tenants would put the keys in an envelope, send them back to the mortgage company and walk away from the loan. The strategy comes down to this: Go ahead and take us to court for breaking the lease. You’ll go through all that time and expense and wind up getting what you’re getting now—nothing.
There’s another category of tenant pursuing much the same goal—lease concessions—but making much less noise about it and with considerably more clout to bring to the discussion.
Starbucks, the trade publication Restaurant Business reported, wants at least 12 months of lease concessions from its landlords. Some have gone further: Staples, Burlington Stores and Dick’s Sporting Goods didn’t pay a portion or all of April rent, the Wall Street Journal reported landlords as saying. Cheesecake Factory told property owners it would withhold April rent payments.
This presents quite the dilemma for property owners. These are companies with the size and wherewithal to tie up a landlord in court for month, should it come to that. These are companies with enough locations to do some damage should they decide to close up at their present locations because they’re mad at their landlords. The big dog with the low growl is likely to get more response than the small, yappy dog. It does make you wonder, though, how this plays out when both dogs involved are of the oversized, slightly menacing variety.
There’s a long game in play here too. Suppose property owners take a hard line with tenants and wind up chasing them away. What replaces them? Small independent businesses? Whoops, they all went under from lease obligations they couldn’t meet. Big chains? If the post-COVID world means even more people working and shopping from home, then tenants for retail and office properties become even more valuable, and scarce—and they’ll have long memories about who played ball when times were tough.
So what we’re left with is a standoff, with both sides having something to lose even if they have a winning position. Lots of canine confrontations end up inconclusively, with snaps, snarls and yelps, but no actual bites or damage. In the commercial real estate world, we’re already at that stage. Now we find out who has more to lose by escalating the showdown.