COVID-19 Commercial Real Estate Update: Quarter Day Analysis and Room for Optimism

The September quarter day saw the steepest shortfall in retail rents paid since the pandemic. However, this was the only sector to see rent collection down on the previous quarter. Faegre Drinker’s Rajan Shori, Sloan Kelly and Paige Izquierdo assess the latest data on how COVID-19 has impacted the commercial real estate sector.

COVID-19 Quarter Day: Retail Spirals, but a Glimmer of Hope for General Commerce?

By a shortfall steeper than the one experienced on the last quarter day, retailers paid only 13% of the rent due for the final quarter of 2020, adding debts in excess of £2 billion to the £1.5 billion retail rent payments left outstanding from the first half of the year. Now more than ever, it is important to focus on any positives — and this quarter did see marginal improvements on the last. Across all categories of commercial tenancies, landlords received 22.1% of rents due and 31.8% in the office sector — up from 18% and 22.7%, respectively, in June.

Offices

Though remote work has become the norm, at least for now, London office investment agents are cautiously hopeful about the final quarter following several high-profile deals in central London. With £3 billion of office buildings currently under offer in the capital alone, London is still viewed by many as a secure investment based on established fundamentals. Today we hear that the U.K.’s highest office rent deal has been agreed by a private family office taking 3,000 square feet at £275 per square foot in Mayfair’s Berkeley Street. This assessment of office investment opportunity appears to be present throughout the country, as 300,000 square feet of office space is being developed across Yorkshire. In Birmingham, German investor Union Investment has acquired a six-story workplace, and in Manchester, new plans to transform the iconic “Kendals” building on Deansgate into world class offices have been unveiled today, adding 500,000 square feet of much-needed quality office space.

Retail

As expected, the figures from this quarter cause the most unease for retail landlords with rental income continuing to fall. The Government extended the lease forfeiture moratorium from September 30 to the end of 2020. These rules do not, of course, prevent landlords from pursuing tenants to pay rent. The owner of Westfield believes Boots’ classification as an essential retailer (permitted to continue trading throughout the lockdown announced at the end of March) means withholding their rent / service charge is contrary to the intended use of the moratorium; taking advantage of it in an effort to renegotiate aggressive lease terms and is therefore seeking legal counsel. Walgreens Boots Alliance maintains that due to reduced footfall and a decrease in sales of 50% during the first three months of lockdown, they should be treated similarly to retailers who were forced to close. It remains to be seen whether this dispute will make it to the High Court and what, if anything, this will mean for other essential retailers who have been utilising the moratorium. Watch this space!

The diminished prospect of retailers meeting their rental payments has encouraged Colliers International and CACI to develop lease models that will instead link rent payments to shopper visits in store and online. These models consider variations of factors such as footfall, increase in online sales after the opening of a store, the value of items bought online for collection in store, physical ‘dwell time’ and in-store sales. More sophisticated “Performance Rents” — rather than “Turnover Rents” — might be a way forward.

One success story to come out of the retail sector this quarter has been the £6.8 billion Asda takeover by brothers Zuber and Mohsin Issa as backed by private equity group TDR Capital, bringing the supermarket chain back into British ownership for the first time in 21 years.

Leisure & Hospitality

Landlords and creditors have continued to approve CVA’s across the retail, leisure and hospitality sectors throughout this quarter, opting to safeguard agreements based on lower rents over risking tenants feeling pressured into accepting more severe insolvency procedures should their proposals be rejected. Recently approved CVA’s include New Look (where 402 stores have moved to turnover based rent agreements) and Pizza Hut (where landlords accepted a reduction in rents to protect approximately 5000 jobs because they ‘do not expect sales to fully bounce back until well into 2021’). This sentiment is mirrored by some 82% of hospitality businesses who say they need a reduction in rent to survive the winter months, particularly after the Government imposed its 10 p.m. curfew and with further restrictions expected imminently.

Times are undoubtedly tough for the many commercial landlords experiencing cashflow problems caused by reduced or absent rent payments and for the retail property owners facing store closures. 14,000 high street stores were forced to close this year, up one quarter from the same period in 2019, due to a predicted £9 billion loss of sales over lockdown. In light of the pandemic, 10% of those closed are expected to never reopen as a retail outlet, and more than a third of British high street landlords are currently repurposing some of their retail portfolio, with a further 57% considering doing the same. However, repurposing during the current climate comes with its own risks and limitations.

Warehouses & Logistics

On a more positive note, a record amount of warehouse space was let in Q3, driven by online retailers looking to expand capacity to meet the increased demand during lockdown. The past six months has witnessed take-up in excess of the annual total for 8 of the past 10 years.

As stated in our commentary on the June Quarter day, we still expect to see a rise in the number of tenants looking to renegotiate leases to take advantage of the new, but increasingly familiar, market conditions. There will be strategic benefit for most landlords to work jointly with their tenants and bankers to explore methods assisting their businesses to endure these unique times. Other solutions are, of course, available to be pursued where necessary. Faegre Drinker’s COVID-19 Real Estate Task Force is available to ensure that all matters are carefully considered and that all lease variations, agreements and concessions are strategically agreed and appropriately documented. For guidance on the real estate challenges presented by the pandemic, please contact one of the authors below.