The COVID-19 outbreak has had a devastating effect on the retail sector. With governments forcing nonessential retailers to close their doors in March, many opted against paying rent in April to conserve cash. They've continued holding back rent in May -- to a greater extent in some cases -- even though governments have started lifting restrictions, allowing retailers to reopen.
These rent collection shortfalls are having a significant impact on landlords like real estate investment trusts (REITs) that focus on owning retail properties. Most had to take steps to shore up their liquidity, including suspending development projects and dividend payments. If rental collection rates don't improve, these REITs might not reinstate dividends or restart development projects and could soon face other financial issues.
A worrisome trend
Many retail REITs have started reporting their monthly rental collection rates to keep investors informed on their progress. For example, when Kite Realty (NYSE: KRG) reported its first-quarter results in early May, the company noted that it had only collected 67% of the rent it billed in April. Kite Realty provided another update about a month later, stating that it had since received 76% of April's rent, though May collections were only at 66% of rent billed. This decline came even though 91% of its tenants had reopened in some capacity by early June, compared to 51% in April.
Urstadt Biddle Properties (NYSE: UBA) reported a similar trend when it provided its latest update in early June. The company noted that while it had collected 68.7% of the rent it billed in April, May's collection rate was only at 60.3%. Seritage Growth Properties (NYSE: SRG), likewise, saw its rental collection rate decline from April to May (65% versus 52%) as of its latest update in early June.
It wasn't all bad news. Kite Realty noted that "while still early in the month, June 2020 is trending ahead of both April and May at the same point in time." Meanwhile, both Urstadt Biddle and Seritage Growth said they completed rent relief agreements with many tenants, which should enable them to collect their back rent in the coming months. In Seritage's case, it will allow one of its tenants to defer 100% of its base rent at five locations for six months, with the deferred rent payable over the subsequent 12 months.
The trickle-down impact
While retail REITs and other landlords are working with tenants to ensure they continue paying rent, many concerns remain. For example, Urstadt Biddle Properties increased its provision for uncollectible tenant accounts receivable by $1.5 million during the most recent quarter, suggesting that it doesn't expect to receive these payments. Meanwhile, even though Seritage agreed to defer rent for several of its tenants, there's no guarantee they'll be able to make these future payments, given their already troubled financial positions and the increasing pressure on the retail sector.
If these retail property owners continue to experience low rental collection rates and don't eventually receive back rent, it will have a meaningful impact on their financial results. It could prevent these companies from reinstating their dividends and moving forward with the redevelopment projects necessary to attract new tenants to their retail centers.
For example, Seritage Growth Properties put nearly all of its projects on hold at the end of March. It had $520 million to $600 million of remaining capital spending under its current retail redevelopment plan as well as another $325 million to $350 million for three multifamily projects as part of the first phase of larger mixed-use developments. Those projects are crucial to its future.
One issue that could hold back development spending in the sector is rising leverage ratios. For example, Kite Realty's debt-to-EBITDA ratio was 6.4 times at the end of the first quarter, which is above the sub-6.0 target of most REITs. One reason it has risen to that level is that the company booked a $2.9 million charge relating to rent reserves during the quarter, without which leverage would have been a more comfortable 6.4 times. If leverage at retail REITs continues to rise, it will restrict their ability to invest in their properties and likely force some to sell assets to reduce debt.
Retail REITs are in a tight spot
Rent collection is the lifeblood of any landlord. Unfortunately, the COVID-19 outbreak has slowed this vital flow of cash to many REITs, especially those that own retail properties. If collections don't improve, that will constrict the financial flexibility of these REITs, which could have serious long-term ramifications.
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