The Riches Back to Rags Story of Today\’s Retail Property Owner \”The Cruel Reality\” Part 1.

The Riches Back to Rags Story of Today’s Retail Property Owner
“The Cruel Reality” part 1.

{3 minutes to read} 

• Sam Liebman
• December 11, 2021

This article will discuss the insurmountable difficulties currently facing 9 out of 10 retail property owners and why I believe a tremendous opportunity will soon present itself for new purchasers to acquire these properties at bargain basement prices. Currently retail properties are circling the drain.

Even before COVID there were warning signs of trouble brewing for retail properties. Online shopping was growing at warp speed causing; a steady decline in revenues, increased vacancies and closures for brick and motor businesses. The near future will bring technological advances such as virtual reality, 3D viewing, and Artificial Intelligence that further threaten their relevance and survival. Younger generations such as Millennials continue to bring lifestyles changes that are directly changing the retail landscape. COVD simply added steroids to the equation.

In my opinion, retail properties will soon experience a devastating collapse in property value resulting in an avalanche of lender foreclosures. Lenders will be inundated with properties that are worth substantially less than the principal amount of the mortgage. This will cause lenders to unload these non-performing assets at discounts of 30% to over 50% of their mortgage balances. I have witnessed a similar scenario in the early 1990’s and history does repeat itself.

 

The question will be, even at an enormous discount does it make economic sense to purchase these retail properties? 

 

Below is a summary of the devastating financial effects caused during the pandemic that continue to haunt retail property owners. 

 

• Many tenants stopped paying rent and other obliga1tions partially or entirely causing large accruals that owners will never be able to fully collect.

• With little or no revenue received during this period owners still needed to make loans or invest additional capital to pay the operating expenses and debt service of the property.

• Many property owners received 3 – 6 months of interest and/or principal deferrals from the lender which will need to be repaid in the near future.

• Many tenants were indeed suffering but others chose to selfishly use the pandemic to renegotiate and lower their rent significantly. This reduction in rent and NOI has caused a devastating effect on cash flow and property value.

 

Example:

A tenant occupies 5,000 SF on a triple net basis @ a rent of $40 per SF. Assume, this tenant successfully renegotiated for a reduced rent of $35 per SF. The result is a decrease in NOI of $25,000. Assuming a 6% cap rate the property value would decrease by a whopping $416,667 and this represents an example for only one tenant.

 

Unfortunately this trend continues to be the new norm and not the exception. It’s now a one way tenant’s market and they are asking for the earth, moon and the stars in exchange for their tenancy. The poor retail property owners financial losses keep mounting up with seemingly no light at the end of the tunnel.

The Bleeding Continues

Many tenants, especially restaurants were forced to file bankruptcy or close permanently. Property owners will not only need to continue funding the shortfalls but will incur the following significant additional costs to obtain new tenants.

1. Vacancy losses.
2. Pay a brokerage fee.
3. Offer free rent periods of 3 – 8 months
4. Offer and fund tenant improvement allowances (“TI”) of $25 – $75 per SF.
5. Tenants may demand a pandemic cancellation clause in their leases.
6. Tenants will be less likely to provide personal guarantees which will reduce the creditworthiness of the property.

Additional Unpleasant Realities.

The pandemic has rendered the owners original goals unreachable. Potential profit has been replaced with survival.

• The immediate area is inundated with retail vacancies. Less demand has caused rental rates to plummet. Existing and prospective tenants will negotiate for many non-traditional concessions and more owner representations.
• The property may now be worth substantially less than the principal amount of the mortgage with the owners invested capital wiped out.

• The mortgage term may soon be expiring. It will be extremely difficult, if not impossible to obtain a new mortgage unless the owners are willing to significantly increase their capital investment and provide a personal guarantee.

• Cap rates are increasing causing property values to decrease substantially and although interest rates remain low lenders do not want to lend to retail properties. Lenders are now requiring significant interest escrows and other reserves which will further decrease owners cash-on-cash return on investment.

• Owners continue to be prohibited from evicting Covid affected tenants for not paying rent.

• New and existing tenant spaces may need to be retrofitting for new health and safety laws. OUCH!!

 

The million dollar question for owners is; What do I do? What are my Options?

Part 2 of this article will try and answer these questions and show why there will be a tremendous opportunity for new investors to acquire retail properties at bargain basement prices.

 

Please read Part 2 – The Unpleasant Options for Retail Property Owners.

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Sam Liebman is founder and CEO of WealthWay Equity Group LLC, a New  York-based private equity and real estate development company. He has owned substantial interests in over 70 properties during the past 30 years, ranging from multifamily communities, office buildings and shopping centers, to the ground up construction of a luxury 21-story condominium development in Manhattan. He is also CEO of Rolling Cash Realty, Inc., a real estate management company, as well as a partner in Tepper & Co., a certified public accounting firm. His new book is Harvard Can’t Teach What You Learn from the Streets: The Street Success Guide to Building Wealth through Multi-Family Real Estate (Made for Success Publishing, Jan. 11, 2022). Learn more at samliebman.com.