Restaurant Owners Renegotiate Rent

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Restaurant owners who have survived four months of a pandemic have earned their seat at the negotiation table. Employing one in every 10 U.S. workers, restaurants have foregone $120 billion in revenue this year—a loss that is likely to double in the next six months as COVID-19 continues.

By March, 3% of U.S. restaurants had permanently closed. Another 11% closed during April. By the end of 2020, at least 25% of the country’s 500,000 independently operated restaurants will shutter, in the absence of additional fiscal stimulus. The National Bureau of Economic Research predicts an even more dire future by 2021, with 85% of restaurants closing if the pandemic does not end this year.

One of the largest tenants of the commercial real estate industry, restaurateurs as a group are uniquely positioned to renegotiate their rental contracts. Our own channel checks in Miami Beach’s highly desirable outdoor mall of Lincoln Road indicate that fully half of restaurant tenants have signage indicating their permanent closure.

Why should renters keep paying old rent prices, when the current reality for retail is nothing like it was before COVID-19?

Nationwide, the U.S. commercial property market froze during the pandemic. Closings fell 79% in May compared to last year. Transactions during May fell to $9.8 billion, the lowest figure since 2010. Retail property closings fell a staggering 83%.

The U.S. Bankruptcy Court for the Northern District of Illinois published its ruling on June 3 decreeing that that a restaurant lease’s force majeure (“Act of God”) provision partially excused tenants’ obligation to pay rent during the COVID-19 pandemic. The ruling applies to restaurant owners across Illinois and sets precedent for other states; the tenant in this case was Hitz Restaurant Group, operator of several bars and restaurants in Chicago.

Were rental prices appropriate even before COVID-19 struck the global economy? According to Nick Halaris, President of Metros Capital, “To really understand what’s about to happen in the real estate market in America, we have to remember a few things that were true about the pre COVID-19 crisis world in real estate.” Halaris continues, “The first thing is, real estate across almost every asset class, in every market in America, was essentially priced to perfection. You had this dynamic where real estate was a beneficiary of the chase for yield that had been going on for a decade… There was a huge boom, and especially in these tech-centered neighborhoods, with offices going crazy in terms of its valuations.”

Next, Halaris explains what has happened for renters since March. “The COVID-19 crisis has revealed a truth about the American economy that everybody knew, but didn’t believe, which is that the vast majority of American families are incredibly vulnerable to any economic shock.” Indeed, within one month of the onset of the pandemic, the U.S. government passed fiscal stimulus packages exceeding $4 trillion, which is more than four times the amount of stimulus unleashed during the Great Recession of 2009.

Third, Halaris explains the impact of government policy. “What happened in the immediate response to the shelter-in-place orders, is the local governments, state governments, passed eviction moratoriums, and the politicians that passed these were advertising them in a way that, here in California for example, it was almost, like encouraging people to not pay their rent.”

What is the result? According to Halaris, for landlords, “In some cases, it’s like a nightmare situation. If you happen to be in a creative office or shared co-working space, this is like an extinction-level threat for these places and I think they know it. We have an office space, and we work here, and they’re offering free rent. They’re trying to get people to stay, but it’s just mass move-outs. I read a report… Some people have reported less than 50% of collections, and some, it’s closer to 90%… Retail’s got to be the worst, and hotel. I guess hotel is probably the worst, but retail, I’m hearing that even in the really affluent malls in and around Los Angeles, it’s like 20% of the tenants pay that rent.”

Restaurant owners seeking to renegotiate rent should arm themselves with statistics about their local real estate market. For example, a non-profit New York City Hospitality Alliance surveyed 509 restaurateurs, finding that 80% did not pay their full June rent obligation. Of those, 90% of tenants said they paid half or less of what they owed. Statistics like these will help strengthen the negotiating power of restaurant owners with their landlords.

The migration away from expensive cities toward suburbs and less expensive metropolitan areas was already underway before the coronavirus. Indeed, restaurant owners in aggregate have been slowly withdrawing from urban centers since 2015.

Halaris concludes, “What people need to really understand about commercial real estate—this applies to all of it, multi, office, retail, hospitality—They never had a vacancy or a bad debt assumption that was anywhere close to what happened in one month. You’re going to have a significant number of balance sheets that are just impaired, and they’re going to have to be restructured, and we think we’re going to see that. Icahn is probably right, there’s going to be some serious price declines in commercial real estate.”

Should restaurant owners feel awkward or timid about calling their landlords to renegotiate rent? Halaris says absolutely not. “If you own those properties, you’re in trouble. Talking to my friends that are the bankers of the world, they literally spent the first two weeks of this in March, negotiating forbearance with all of their property owners that own retail and office. That was all they did.”

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