Kenneth Schuckman on the State of the Real Estate Market,
Covid-19 Shutdown and Beyond.
The following is an excerpt from an interview with Kenneth Schuckman, President and CEO of Schuckman Realty Inc. and his thoughts on the current state of the real estate market at the end of April 2020.
Q: What are your thoughts on the leasing environment now and in the near future?
KS: What we are experiencing right now, for the most part, in small-store leasing is a complete shutdown. So, small store leasing, whether it was Midtown Manhattan or Eastern Long Island, whether it is a shopping center, urban environment, or street retail, is an absolute shutdown.
Now what we are seeing is some credit tenants that are deemed essential, do have aspirations for expansion. For example, we work with CVS Health and Lidl Supermarket, they are actually ramping up expansion and we currently have deals that active with them. The difference between three months ago and today, is that three months ago, we had a pretty strong market environment. Three months ago, small business expansion was working well, whether it was medical tenants or experiential retail, such as health clubs and restaurants. For the most part, the retail real estate economy was quite healthy.
As it relates to what is happening now, all that experiential retail, which was the darling of expansion, but required people to be together, is shut down. The prospect of that type of retail returning to “normal” or pre-crisis revenue in the next few months is very low.
Family and theme restaurants will need to reconfigure their dining floor plans to assuage the customers fears, therefore expansion will be halted for the foreseeable future. Quick service restaurants (QSRs) through franchise growth, especially drive-thru concepts, should see more relative growth than other restaurant operations. The independent sit-down restaurants without deep pocket reserves could face extinction. Somebody asked me for a quote on a market rent, my response to them was …”do you want the market rent from January or for May, because they are two vastly different numbers?”
Different industries and spaces in the retail market will be impacted differently. We are seeing supermarkets surging, we are seeing drugstores surging. In the future, we will be seeing more medical concepts in the retail environment. I see that type of tenant proliferating with the government stimulus program. In addition, the online retail story has just begun, retailers who use the Internet as their primary customer experience will be using the downturn to infiltrate the brick and mortar segment more than ever before.
Q: What do you see looking forward:
KS: There were a lot of retailers who were struggling before this pandemic, let’s call them the victims of on-line shopping. Those tenants, whether it is department store space, dry goods space, or the apparel space, all of these non-experiential retailers that were being affected by the Internet, I had a five-year horizon as to their potential demise and analysts were telling me that 50% of department stores were going to be closed within the next five years. I think that time frame has been accelerated to 12-18 months as a result of the recession due to the Corona Virus. For some retailers there will be a depression, even if the economy does recover quicker than anticipated because this was inevitable, and those dates of reckoning have been pushed closer to the present rather than into the future.
Q: What about retailers who seem otherwise “healthy”?
KS: You are going to see a lot of tenants who have closed all of their stores. Typically, on their earnings calls, retailers talk about how many stores they will be closing that were not profitable. If you have a chain of 1600 stores, and they are all currently closed, they may only reopen half of them. It may not make sense to re-open some of those stores when they have already furloughed or laid off their employees. Historically, Wall Street never wanted retailers to close stores, so many retailers kept stores open. Now, however, Wall Street believes, rightfully so, that the average retailer has too many stores, so a chain is now looked at favorably when it closes stores and reduces its brick and mortar footprint to keep it in business.
Q: Many tenants who have been adversely impacted by on-line retailers are located in shopping malls. How will this impact the malls?
KS: Prior to this crisis, you had about 1200 department store anchored malls in the U.S. It was determined that we only needed 350-400 malls to meet the consumer demand. So less than 25% of the existing inventory was needed. Now every shopping mall has been forced to close, no rent being paid, and there will be an issue with the big malls surviving, which were already struggling. Recently, we have seen mall owners get together and “bail-out” retailers, because they felt were better off buying the company, then to try to refill the vacancy. There simply aren’t enough retailers out there to refill those spaces. After this crisis, mall developers and owners are going to have more issues, because of the accelerated timeline of the extinction of certain retailers. Those retailers may not reopen in some malls, causing many more vacancies. If you have mall stores that rely on the anchors bringing in traffic, and half of those anchors do not reopen, some of the smaller tenants, may say “why is my store in the mall?”, and choose not to reopen those locations.
Q: Do you think the case of mall owners purchasing retailers to keep spaces full will be a trend?
KS: No. I do not think as a long-term strategy, the purchasing of retailers by mall owners as a tactic of survival will continue. That was previously an act of desperation and I don’t see that as being a viable option moving forward.
Q: What about rent reductions and/or tenants not paying rent.
KS: We were already experiencing compression of rents before this because as big-boxes were becoming available and weren’t getting filled, it was impacting rents. It’s all about supply and demand. If we have a significant number of businesses not reopening, you will have more space on the market. More space on the market means lower demand for space and therefore rents will be driven down. One trend we are seeing now is that now many more people are embracing online shopping. Also, the people who were already shopping on-line have only increased their frequency and volume of online purchases. For example, seniors who did not adapt to on-line shopping and who now cannot leave the house, have embraced online shopping. We saw this in China when the stores reopened, a lot of the sales did not return to stores, those sales have been permanently replaced by on-line shopping. So that is yet another existential threat to brick and mortar retailers whose channels of distribution were sub-par to the on-line world and many of their e-commerce websites were terrible. This will be a new hurdle for those retailers after this crisis.
With regard to tenants not paying rent, when I was previously interviewed on this subject, many of the accountants and lawyers were advising retailers not to pay rent, so the rents that came in were about 25 – 30 % in April. Therefore, the question is what are landlords doing to survive? I’ve spoken with landlords large and small and the position they are taking is that they will assist tenants in getting SBA loans, but they still need them to pay their rent. Another discussion that is taking place is that landlords may be giving rent deferrals to small businesses for or one or two months. If it is a large credit tenant, or a tenant with a high net worth, especially if they remain open, nothing changes and those tenants are expected to pay rent. I know there have been companies that have asked for 12-month deferrals or even asked for a rent holiday, which will ultimately be litigated once the courts reopen, so it remains to be seen after the crisis.
Q: What does this mean for future occupancy?
KS: Prior to this crisis, there was three to five percent vacancy that would not be replaced. Typically, there is an absorption rate, but now we will have a net-net negative absorption rate. When it comes to the major real estate investment trusts, they are anticipating the new normal is to have an additional three to five percent vacancy. Over the next six months, we have to see how many tenants will be going out of business or declaring bankruptcy and how many tenants will reopen. Everybody is hoping that with stimulus once Corona Virus is over, people are going to go back to shopping with consumer confidence going through the roof, but I don’t think that is going to happen. We have double digit unemployment and the question is how quickly these people will be rehired and I am not optimistic about it happening any time soon. I am optimistic about the second half of 2021. However, for the next nine to twelve months we will have a very serious economic issues in this country and that will result in people not going back to the stores. So even if and when stores reopen, the question is what is going to happen to these stores once they open.
Q: What is the big takeaway here?
KS: Honestly, in terms of what Schuckman Realty does and what our industry does, we are going to see generational opportunity as far as real estate. People who were never sellers, will sell. Landlords will be trying to fill space and there is going to be great opportunity for diligent real estate professionals in this industry.