Restructuring and Other Lease Decisions: Wait or Go for It?

Tell us a little about your company and its growth over the last 30 years.

Our lease restructuring and lease renewal divisions have grown steadily over that time, but I think in times of distress or disruption, the requirement for our services increases. There was a whole era of lease restructuring spurred by the financial crisis in 2008 and the ensuing recession. The pendulum swung in the direction of retailers and has predominantly stayed there, but that may be changing.

The pandemic and lockdowns certainly meet the definition of disruption. Two years later, what are you seeing in the market and why do you think the pendulum may be swinging away from retailers?

A vast amount of space came online during the pandemic as retailers realized that they had too many stores in specific markets, and a lot of stores just didn’t make it. There were a lot of closings and bankruptcies, and that space is still being absorbed today. Many retailers are also still shaking off the pandemic as it relates to lockdowns, and they’re looking to clean up their store fleet and see what works the rest of this year and maybe into next year as we get out of the pandemic stage and hopefully into an endemic. Perhaps they’re in an area where many people are still working from home and [retailers] are waiting to see if people are going to go back to the office. Some retailers are going through mergers and have to decide how to integrate from a real estate perspective. That could mean more dispositions on the horizon.

But there are also a lot of retailers that have opportunistically expanded into markets at much lower rental rates due to the pandemic. That gave them a chance to saturate markets that they were in or enter new markets. Now rental rates in many markets have either fully rebounded to pre-pandemic levels or are at least approaching them. In the first half of 2021, rents rose by one-tenth of a percent nationally, but in the second half of the year, they rose 3%. It’s too early to tell what the rental rates will look like this year, but our sense is that they’re going to increase, especially in tighter markets.

How big of an appetite is there for lease restructurings?

As retailers recognize that rents are likely to rise in the near future, we are seeing a lot of new clients come on board. They definitely have a purpose and want to be aggressive in restructuring their leases. They want to control the rent-to-sales ratio, but they also want to go about it thoughtfully and involve implementing a precise process and methodology. It’s a big country, and you have to look at each submarket and determine what you’re paying relative to the specific market; did something happen in the market that pushed up the rents or made them go down? It could be that your center lost a large box and you have certain rights to reduce your rent, not pay rent or even possibly leave. Or maybe there has been a change in demographics. These are just some variables that retailers must examine and work through today.

At the same time, inflation has taken hold. It seems like landlords are thinking about their dollars today being worth less tomorrow, and some are pushing back on restructurings. Of course, the Fed will fight inflation with aggressive and frequent rate increases, but who knows how all of that is going to pan out?

Would it be wiser to wait to see how inflation and interest rates shake out? Is there a danger in negotiating now versus later?

I would say no. Most of the retailers we work with have very large fleets and leases are forever expiring, so I think of it as dollar-cost averaging. There are only so many leases a retailer can restructure in a year depending upon staffing, decision dates and a host of other factors. But many strategies can help you reduce your rent-to-sales ratio or keep it as tight as possible relative to the facts on the ground to be successful in this market. How you go about negotiations and where you find your wins might change slightly. Retailers have to look at their fleets and decide what can be restructured and what can be closed and what are the costs associated with those actions.

What other trends are you seeing?

We’ve disposed of a lot of owned real estate during the pandemic. Cap rates have gone so low that any freestanding building, corner space or decent land is selling very quickly. That’s primarily because of the pandemic. Many end users desire to move out of their inflexible current spaces and into spaces where they can put in a drive-thru.