Archives for October 2020

Changes to city policies, zoning, and leasing agreements are needed to accommodate the altered commercial landscape brought on by the pandemic.

3 Takeaways:

• Cities are reevaluating policies and zoning laws to help retailers do business during the pandemic.
• Evolving business models are necessary to accommodate consumer behavior.
• Changes to lease structures will help ensure tenants can afford to stay long term.

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For the past eight months, independent retailers, big-box chains, and restaurants have grappled with the ongoing pandemic and its effects on brick-and-mortar locations. Retailers of all kinds have had to improvise, pivot, and change amid everything from shutdowns and restrictions to changes in consumer behavior. Meanwhile, cities have been given new insights into how zoning and policies affect a business’s ability to weather crises.
The city of San Francisco, a vibrant community of multiple neighborhoods—each with its own distinctive flavor of retail—has been hit particularly hard by the COVID-19 pandemic. According to a recent Yelp Economic Impact Report, San Francisco has the third-highest number of retail and restaurant closures in the United States. Only New York City and Los Angeles have seen more businesses shut down.
A panel discussion at the 2020 Urban Land Institute Annual Symposium focused on the inevitable changes needed for brick-and-mortar retail to survive in an age of never-ending uncertainty. The discussion was led by Sheila Nickolopoulos, a senior planner with the city of San Francisco; Laura Sagues Barr, senior vice president of CBRE; and Laurie Thomas, executive director of the Golden Gate Restaurant Association.
As a result of mandates meant to curb the spread of coronavirus, restaurants are currently able to use 25% of their indoor dining spaces to seat patrons. Similarly, local businesses are allowed only a small number of patrons indoors. This has forced owners to pivot to new ways of serving their customers: via curbside pickup, delivery, and outdoor seating and selling.
At the beginning of the pandemic, though, restaurant and retail owners could not use the sidewalks in front of their stores, nor adjacent open spaces or parking spaces for seating or selling products. This, Thomas said, caused significant problems in the retail sector’s ability to evolve as quickly as it needed in order to stay open and serve customers.
The problem, Thomas said, stemmed from city policies that require thousands of dollars in fees and what she called an “arduous permitting process” that could take months. But restaurant owners did not have months to weather the pandemic while waiting on the proper permitting, and most did not have the cash flow to pay the necessary fees.

Policy and Zoning Changes Are the Future

San Francisco has long known that it’s time for a close look and overhaul of retail-related policies, which Nickolopoulos said do not reflect the current retail environment. The city already had plans to reevaluate its policies, but the coronavirus accelerated the process.
A task force composed of city and community leaders came together in an effort to figure out what immediate changes were needed to help businesses survive the pandemic. One resolution that came out of the task force is the Shared Spaces Program, which streamlines the process of allowing restaurants to quickly pivot to outdoor dining, a move Thomas said provides a necessary—but temporary—lifeline for restaurants.
The city continues to work with small businesses and restaurants to make doing business during the pandemic as easy as possible.

Lease Structures Are Changing

The ability to keep a brick-and-mortar retail space open depends on a number of factors: cash flow, business costs, rent prices, demand, and more. The pandemic interrupted cash flow for most businesses in San Francisco and beyond. Also, the retail sector had been dealing with rising rent costs and steady increases in the price of doing business. This combination of factors has made it more difficult for retail and restaurant establishments to make a profit, forcing many businesses to close.
For existing and new businesses, a change in deal structures will likely be needed to ensure tenants can afford to stay long term.
Sagues Barr, who works with many commercial retail investors, said those changes are coming down the pike. The good news, she said, is that she’s seeing an uptick in investors who are ready and able to invest in becoming landlords.
Still, for commercial leasing to be a viable source of revenue for investors, they need tenants to fill the space. Given the pandemic, the investors understand the need for flexibility in deal structures, and Sagues Barr is seeing an implementation of new leasing terms. She identified three deal structures evident in the commercial space:

1. Straight percentage deals for the term of the lease.
2. A set base rent with a percentage structure set for a period of time.
3. Percentage structure for the term of the lease (typically 18 to 24 months) that has a base rent reset based on sales.

Flexibility Is Critical

All three panelists agreed that for commercial sectors to survive the pandemic and beyond, flexibility is nonnegotiable.
From a policy perspective, Nickolopoulos said, this means making short-term changes to accommodate current commercial needs—like the Shared Spaces Program—and looking at current policy that prohibits businesses from pivoting as needed. Long-term fixes will also be necessary to make it easier for businesses to make money.
Retail establishments and restaurants will need to find new, innovative ways to get their product to their customers, Thomas said, which means revolving business models to accommodate consumer behavior and working with the city to break down barriers that prevent businesses from doing just that.
Landlords will also have to take a short-term risk for what’s hopefully a long-term win, said Sagues Barr. She also emphasized the importance of landlords and tenants coming to agreements that work for all parties involved, which means agreements might have to evolve into something new.

The Takeaway

Cities overall are resilient, which is a positive. The brick-and-mortar shopping experience isn’t going anywhere, but it is changing in myriad ways, which means commercial real estate brokers, agents, and investors will have to keep a close watch on many factors. Everything from city policy to leasing agreements will likely change in some way to accommodate the new normal brought on by the pandemic.
Because the United States is still in the midst of the pandemic, it’s hard to predict what the future of commercial real estate will look like. This isn’t the time to gather data on vacancies or business health, said Nickolopoulos, because right now, retailers, investors, and cities alike are simply focused on staying afloat.
Source: “The Transformation of Retail Spaces to Keep Businesses Going“

The economy is now out of the technically deepest recession in US history as the GDP rose at an annualized rate of 33.1% in the third quarter. The recovery had been expected, given earlier strong indicators on housing, employment, and retail sales.
Fueling this recovery was strong personal consumer spending, which rose 40.7%. Consumers opened their wallets on every type of consumer item, but especially on recreation, food services, and accommodations, as the economic lockdown ended in Q3.
Business investment spending surged on the back of strong residential investment that rose by 59.3%. The housing market has had a spectacular recovery with mortgage rates at 50-year lows, hovering at below 3%. However, commercial investment spending remains depressed, with investment spending down by 14%, as businesses deal with the challenges and uncertainties of working from home on office space, the acceleration of e-commerce, and rent payment risks, as the $600 federal unemployment assistance ended in July. About 27% of renters, or 14.2 million, are worried that they can’t pay rent or will have rent deferred.
The real estate market—which accounts for about 20% of GDP—has been key to this quick V-shaped recovery. With mortgage rates hovering at below 3%, and given the strong showing of the housing market, the market should continue to support the economic recovery.
However, there are headwinds facing the economy in the next six months—the resurgence of COVID-19 infections, the end of the $600 federal unemployment insurance, as well as the expiration of the pandemic unemployment assistance for self-employed or independent workers that ends December 31. About 10 million people are accessing that benefit.
Source:”Instant Reaction: Third Quarter GDP, October 29, 2020“

The former Vice President proposed ending 1031 “like-kind” exchanges for investors with annual incomes above $400,000.

Like most Americans, Chris Pappas, associate director with Marcus & Millichap’s Net Lease Division, is keenly attuned to what is happening in the Presidential race.
If former Vice President Joe Biden wins, Pappas is prepared for the demise of the 1031 exchange program. In July, Biden proposed ending 1031 “like-kind” exchanges for investors with annual incomes above $400,000 to fund child care and care for the elderly, which is projected to cost $775 billion over 10 years.
“For the net lease sector, one of the big questions is whether or not a Biden administration would try to terminate the 1031 exchange,” Pappas says. “That is on the table.”
If it happens, Pappas expects a big influx of inventory from owners that have been considering a transition into NNN management free assets, which are the ones that he sells.
“Owners of management intensive assets will likely look at news of a 1031 repeal as their last chance to sell their assets and transition into triple net properties without having a major tax implication and completely defer taxes,” Pappas says.
Long term, Pappas thinks a move to end 1031 exchanges could change the way investors look at sales.
“Owners would be less likely to sell because they don’t have the ability to defer taxes,” Pappas says. “This will absolutely be a material consideration in the sale decision. Repealing the 1031 will likely result in a major transaction volume decline as many investors opt to hold until they receive a tax basis step-up upon death. However, repeal of basis step-up is also being discussed which would also have a seismic impact. For those in the NNN sector, these proposals are definitely something we’re concerned about.”
Over the summer, 1031 investors helped drive velocity in an otherwise floundering net lease sales market after they were given an extension by The Internal Revenue Service in April. h
Right now, those 1031 exchange buyers are fading as the year comes to a close, regardless of what happens in the election. “What we’re seeing now in our business is that non-exchange buyers are coming back into the business and they are very attracted to the low interest rate environment,” Pappas says. “They have cash that’s been sitting around during the pandemic that wasn’t earning them much.”
Pappas thinks those non-exchange buyers will be active going forward. “They want to get back into the mix because interest rates are so low and they have that clarity of the impacts on each individual sector,” he says.
But Pappas says 1031 investors are still key players in the net lease market, regardless of the cycle.
“The 1031 is often demonized as a loophole for the rich, but it also saved the jobs of many everyday Americans throughout the pandemic,” he says. “Struggling businesses with real estate holdings, such as restaurant franchisees and industrial owner-operators, performed sale-leasebacks during COVID to quickly raise cash to satisfy debt obligations and make payroll. These sale-leasebacks are commonly structured as NNN assets, and without demand from 1031 exchange buyers these companies may have failed resulting in significant layoffs.”
Source: “Net Lease Investors Brace for Biden Victory“