Most financial crises are either seeded in the real estate market or are amplified there. The current one began as a healthcare emergency and has rapidly morphed into a financial shock, but its legacy will perhaps be the most profound in the real estate market.
As in so many sectors, the Covid-19 lockdowns across the world have only served to accelerate technological and behavioural changes that were already under way in the retail, hospitality and office space sectors.
The implications of social distancing and hygiene measures to contain the virus were almost immediately apparent to investors: the largest US retail real estate investment trust (Reit), the Indianapolis-based Simon Property Group, lost 68% of its share price value between Feb 21 ($142.25) and March 18 ($44.92). The $100 billion Reit has more than 22.4 million square metres of gross leasable area in North America and Asia.
“Before Covid, many retail Reits were confident that they would be paying dividends and believed that they just needed to ‘redevelop’ their malls,” says Richard Rubin, CEO at Los Angeles-based Repvblik, which focuses on the adaptive reuse of all classes of real estate into workforce, student and 55-plus housing.
“There was a lot of mention that the malls were not ‘experiential enough’ and that this was one of the reasons that the consumer was not visiting the malls. This is a betrayal of the investor community. The reason why people were not coming to malls is that consumer behaviour has changed, and the likes of Amazon have provided for a more elegant solution.”
The US has 116,000 shopping malls, many of which have anchor tenants such as Neiman Marcus or JC Penney, which have both now filed for bankruptcy. Even as malls start to reopen, a lot of damage will have been done.
On June 6, Simon Property Group sued The Gap, Inc and associated entities for breach of contract and wilfully withholding rent and other lease charges amounting to $65.9 million over the previous three months.
The largest US shopping mall, the Mall of America in Bloomington, Minnesota, missed mortgage payments on its $1.4 billion mortgage in April and May, according to mortgage servicer Wells Fargo.
The big fear now is that consumers that have been forced to shop online during the pandemic will find that they rather like it and never return. Open-air malls are likely to fare better than enclosed ones, as are malls that have large grocery anchor tenants.
But all rely on small businesses to fill their space, who are typically on five- to 15-year contractual leases and are not in any position to survive a prolonged cessation of business.
It is not only Reit investors that are watching the situation with growing concern.
According to Fitch Ratings, 154 mall and outlet centre mortgages, totalling $16.2 billion, are sitting in commercial mortgage-backed security (CMBS) pools and are set to mature over the next four years. As these loans typically have 10-year tenors, they will have originated in a much healthier environment for bricks and mortar malls than prevails today. (Since 2015, there has been far greater selectivity, which has driven a decline in the number of malls included in US CMBS deals, and an increase in mall quality.)
A lot of retail business cases were on borrowed time before Covid set in
– Richard Rubin, Repvblik
According to Bank of America, the percentage of loans in all CMBS deals that are 30 days or more behind on payments went from 1.3% in April to 5.6% in May. There was a jump of 16.5% for hotel loans and 7.1% for retail loans reporting delinquencies.
“A lot of retail business cases were on borrowed time before Covid set in,” says Rubin. “The retail apocalypse has been captured for some time and malls need to do more than put in a bowling alley and a Chuck E. Cheese.”
Indeed they do, as the latter itself teeters on the brink of bankruptcy as well.
“The knock-on effect of this will be far deeper than it was in 2008,” adds Rubin. “It is far more nefarious and far reaching. The hospitality industry, too, was trading in line with busy business and recreational travel schedules. Even outdated, overpriced hotels were at above 70% occupancy. Then 10 to 12 weeks of a Covid-related slowdown occurred.
“When the stimulus packages run out, a certain vintage of hospitality will not come back.”
This problem is not new: the website deadmalls.com, which tracks America’s retail decline, was set up in 2000. But Covid-19 has turbocharged the need for these sites to repurpose themselves. Adding experiences simply isn’t going to cut it anymore.
Although the US has a far greater density of shopping malls than elsewhere, the problem is a global one. According to consulting group Global Data, six of the 10 largest shopping malls in the UK are financed in the CMBS market.
In mid June, when the UK’s lockdown restrictions were relaxed, prime minister Boris Johnson was pictured in an empty London shopping mall desperately trying to urge the city’s residents to fill it.
Given that he spent the beginning of the crisis enthusiastically shaking hands with potentially infected patients before falling ill himself, many are understandably wary of following his example: although they did visit reopened stores across the country in their droves, nevertheless.
Perhaps the need for retail therapy will be enough to see these sites through until they can find a new raison d’être. Many are in good locations close to dense residential neighbourhoods, so may have a future as residential housing, self-storage, emergency medical facilities or Amazon distribution centres.
That is what investors in both retail Reits and CMBS will be banking on. Indeed, by June 16, the Simon Property Group’s share price was back up to $75.52.