Governments forced many nonessential businesses like restaurants and retailers to close their doors earlier this year to help slow the spread of the COVID-19 outbreak. Because of that, many of these companies held back their rental payments since they weren't allowed to open their locations and generate sales. That impacted the commercial real estate companies that owned space leased to these tenants, with many retail REITs suspending their dividends because of significant collection shortfalls.
However, landlords believe these companies still have a contractual obligation to pay their back rent despite government-mandated closures. Because of that, they're beginning to fight back. One of those leading the charge is top mall owner Simon Property Group (NYSE: SPG), which is suing clothing retailer Gap (NYSE: GPS) over its failure to pay rent in April.
The legal battle begins
Like many nonessential retailers, Gap stopped paying rent in April after complying with government orders to close stores to help slow the spread of COVID-19. Overall, the company held back $115 million in rent and other landlord payments in April. It owes $69.5 million of that to Simon Property Group for rent on its roughly 400 stores in that company's malls.
Gap believes "that strong legal grounds exist to support our claim that we are not obligated to pay rent for the stores that have been closed." However, Simon Property Group believes Gap should pay its rent even though it wasn't able to access those properties. On its first-quarter conference call, CEO David Simon discussed nonpayment by its tenants, stating, "The bottom line is, we do have a contract, and we do expect to get paid."
While Gap has been struggling financially as more consumers shop online, it does have access to funding. The company raised $2.25 billion in debt in late April, despite all the market turmoil. That bond issuance gave it the cash to refinance other borrowings and bolster its liquidity. Because of that, it certainly has the funds to pay Simon Property Group and its other landlords.
More legal action likely
Because Gap has the financial means to pay its rent, more REITs will likely sue so that they get their cut. Several of them count the company among their largest tenants, including regional shopping center owners Retail Value (NYSE: RVL), SITE Centers (NYSE: SCTR), Retail Properties of America (NYSE: R), and Federal Realty Investment Trust (NYSE: FRI). It's one of the top 10 tenants for those REITs, providing them between 1.5% and 2.1% of their annual base rent. Because of that, they, like Simon, have a large incentive to force Gap to live up to its contractual obligations.
Gap is just one of many tenants that didn't pay rent in April and could face legal challenges from Simon and others. Another notable company that made headlines earlier this year was restaurant operator Cheesecake Factory (NYSE: CAKE). It stopped paying rent in April -- including on its 29 locations owned by Simon Property Group -- due to the impact the COVID-19 outbreak had on its sales.
Like Gap, Cheesecake Factory was able to raise capital in April to help bolster its liquidity by getting a $200 million convertible preferred investment from Roark Capital, which boosted its cash balance to $260 million by the end of that month. Because of that, it has the financial resources to pay its rent. If it chooses not to fulfill its lease obligations, landlords might sue. Further, they might not be willing to lease space to it in the future, which could crimp its growth ambitions.
The battle begins
Retail tenants like Gap believe that because governments forced them to close their doors to slow the spread of the COVID-19 outbreak, they don't have to pay rent during that period. Unsurprisingly, landlords such as Simon Property Group disagree and are starting to sue so that they get paid. It's an interesting legal battle to watch since the outcome will likely have a ripple effect on other retailers and REITs.
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