REITs And Rent Payments: What To Expect

Summary

• A lot of REITs are missing rent payments right now due to the economic shutdown.
• We assess the damage across the different property sectors.
• There's one main conclusion: Rents are delayed but not lost.
• Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Get started today »

The coronavirus pandemic is set to cause one of the sharpest retractions in economic activity ever recorded. Goldman Sachs and Morgan Stanley economists predict a 30% drop in the second quarter GDP and unemployment could soar past 25%. Many of you have been asking me:

"How will this unprecedented crisis affect rent payments?"

It's a difficult question to answer because (1) we have never been in this situation before, and (2) it greatly depends on one property type to another.

With that said, I have spent the past weeks calling REIT executives and other contacts I have in the private equity field to gain as much information as possible.

Before we dive into the various property sectors, there seems to be one main takeaway:

The missed rent payments are deferred into the future and remain owed to the landlord. They are not cancelled or forgiven. Therefore, most of the missed payments are expected to be collected by the end of the year 2020 or 2021 at the latest.

If correct, this is great news for REITs as many have been speculating that this unprecedented crisis could lead to rent dismissal due to certain clauses in leases. Based on the current information that we have, this does not appear to be the case.

Residential REITs:

Residential real estate is quite defensive because everybody needs a roof over their head and tenants don't want to ruin their credit by missing rent payments. In a regular recession, rents may go down a bit, but overall, the cash flow remains defensive.

According to the National Multifamily Housing Council, only 70% of tenants paid any of their rent in April's first week. This compares to 82% for April's week one year ago.

So there's a clear impact, but it's not very significant at this point. We suspect that the initial drop in collection rate was caused by (1) residents who were unsure whether the rent was still due, (2) residents who lost their jobs, (3) and residents who waited to first get their stimulus check before paying.

With good tenant communication about rent, the collection rate can be drastically improved. As an example, Independence Realty Trust (IRT) collected ~90% of its rents by April 9, which is fairly normal.

How will they collect the missed payments?

Sam Landy, CEO of UMH Properties (UMH), explains that they have collected over 90% of rents and that all missed rents are expected to be paid over the following four-month period in 25% increments.

Example: If you miss rent for April, you will pay May + 25%, June + 25%, etc… They expect to have collected all rents by the end of this year.

Finally, talking to some close contacts in the private equity field, they expect multifamily real estate to function as a safe haven during this crisis. Then in the aftermath, the demand for multifamily investments is expected to be greater than ever before due to 0% interest rates.

Note that we own three residential REIT investments at High Yield Landlord and they represent 16% of our overall portfolio. Over the coming weeks, we expect to bump that closer to 20%:

source

Net Lease REITs:

Net lease REITs own freestanding single tenant retail properties such as Walgreens Pharmacies (WBA), Dollar General (DG) stores, restaurants, and gyms. Generally, these are some of the most resilient properties during recessions because they earn steady rent checks from >10-year leases.

However, because the pandemic has forced many properties to close down, many rents have been missed.

Spirit Realty Capital (SRC) has provided some of the best data on rent collection:

• 16 of its top 20 tenants have paid rent.
• They received rent deferral requests for 42% of rent.
• They approve only 24% of these requests.

Clearly, the tenants are struggling and it's well reflected in the elevated requests for rent deferral. The most heavily-impacted are casual dining restaurants, movie theaters, gyms, and other entertainment venues.

We expect ~30% of rents to be missed in the coming months for most net lease REITs. However, it's important to note that these rents are not lost, they are just delayed.

STORE Capital (STOR), another net lease REIT, confirms that rents remain due even if stores are closed. The language in their leases is clear. There's no clause for rent dismissal and it's the tenant's responsibility to take insurance against business interruption.

The REITs appear to be willing to work with tenants, but only allow late payments if they have no other options. They don't allow deferred payments by choice.

This is one of our favorite property sectors because while there will be missed rent payments in the near term, we expect most tenants to survive and pay rent at a later date. Rent coverage is 2-3x during regular times, and therefore, even if profitability decreases somewhat, we don't expect major lease renegotiations. Net lease REITs have very strong balance sheets, and therefore, they can weather the storm, and as we return back to normal, we expect a sharp recovery to former highs.

We hold a 23% exposure to net lease REITs and currently own four positions.

source

Mall REITs:

Malls are the most impacted by this recent crisis. Properties are closed, retailers are not making any money, and their liquidity is quickly running thin.

Many tenants already have publicly made it clear that they will defer rent payments in this environment. Some estimates indicate that as little as ~20% of tenants have paid their rent in full.

Yet, even here, this does not mean that the rent won't get paid. According to Taubman Centers (TCO), rent remains due even despite store closures. It recently issued the following note to its tenants:

Landlord's obligation to pay its lenders, utility companies, insurance companies and the like, to ensure the safety and security of the building and maintain the appropriate level of operations, remains. The rental income that we receive from Tenants is essential in order to meet these obligations. All Tenants will be expected to meet their Lease obligations."

This may seem unfair at first, but really when you think about, it's how it should be.

• Owning a mall is a lower risk, lower expected reward business.
• Being a retailer is a higher risk, higher expect reward business.

When you are the landlord, you accept the lower reward because you have a lease in place that provides steady rent payments and protection during more difficult times like today.

Retailers, on the other hand, make great money during good years, but they also are more exposed to economic downturns. If you want to earn these higher rewards, you must also assume the higher risks. And this means that today, you must still pay your rent, even if you are temporarily losing money. You cannot just reap the rewards during good years and then transfer the losses to the landlord during the bad years. That would be unfair.

Now regardless of this, Cheesecake Factory (CAKE), Adidas (OTCQX:ADDYY), Tesla (TSLA) and many others have publicly said that they won't pay rent. If they are running out of cash and fighting for survival, that's the right thing to do. But it does not get them off the hook. Payments will need to be made at a later date, unless the landlord decides otherwise.

So far, US REITs have not made concessions with their tenants. They are ready to exercise their contractual rights to pursue rent collection.

However, you should note that abroad, several foreign REITs have granted financial support to their tenants by means of rent cancellation. Some companies have granted 1-3 months of free rent. While this results in a direct hit, some landlords have argued that it's preferable to take some pain now to assure their tenant's survival, which will allow them to quickly recover in the aftermath of the crisis.

Mall REIT investors should expect significant unpaid rents in the near term, and it will be interesting to see whether landlords grant concessions or play hardball with tenants. We believe the higher quality mall REITs, such as Macerich (MAC) and Simon Property (SPG), are in a better position to exercise their rights because they own the best malls of the nation and have a longer list of replacement tenants in case of lease default.

We currently own two pure-play mall REITs at High Yield Landlord, representing 5.5% of our Core Portfolio.

source

Office REITs:

The performance of office properties will greatly depend on the property quality, lease length and the tenancy.

A landlord of skyscrapers in Manhattan that rents space to law and consulting firms on a long-term basis should do fairly well. These companies lease space in a trophy building not because they have to, but because it boosts their image. Moreover, even in case of vacancy, there's a long line of tenants who would gladly take space in a prestigious building. Rents may go down some, but the superior location and limited new supply are competitive advantages that will remain in place.

On the other hand, the owner of suburban low-rise office buildings with short leases will fare much worse. The biggest risk to a lower quality office building always is vacancy. It's difficult and expensive to release space. and therefore, these landlords have lower bargaining power with their current tenants.

Rent collection will greatly vary across the quality spectrum. We only own one REIT with office buildings, and fortunately, these properties are Class A trophy properties.

source

Industrial REITs:

Industrial real estate will fare better than office because of two reasons: They are more heavily exposed to e-commerce, which is booming right now, and secondly, you just cannot substitute a warehouse or distribution center with Zoom (ZM) conference calls.

However, this does not mean that industrial properties are immune to the crisis. In fact, they are famous for being quite cyclical. If we go into a deep recession, more tenants will default and/or not renew their leases due to poorer business prospects.

Just like office, the main determinant factors here are the lease length and the quality of the tenancy. We only own one industrial REIT and it has eight years remaining on its leases and 80% of its revenue comes from investment-grade tenants. Therefore, we do not expect significant rent collection issues.

source

Healthcare REITs:

Healthcare REITs are resilient to recessions, but not to pandemics. Senior housing and skilled nursing REITs are at risk of virus spread inside their facilities, which could kill residents and delay move ins. These properties already are operating on very tight margins, and therefore, they are quite risky in this environment. So far so good, rents are getting paid.

Hospitals and medical office buildings are somewhat better protected by long >10-year leases and higher rent coverage at 3-5x. However, they are not immune either. The operators of these properties are under severe financial stress due to delays in more lucrative surgeries as they must make space for coronavirus patients. Fortunately, they are getting the right financial support from governments to bridge the shortfall in cash flow.

Rent deferrals may or may not happen, but either way, we expect full payments now or later. Medical Properties Trust (MPW) recently updated investors that it had received 96% of its rents.

One of my private equity connections noted that some of their medical office tenants that do not provide essential medical applications, such as dental, specialty, and colonoscopies, are asking for concessions. The typical deal with them is a deferral of 6-12 months with the logic that a lot of these medical applications will not go away, but will then be booked in higher density at a later stage.

We currently own three healthcare REITs representing 15% of our Core Portfolio.

source

Other Specialty Property Sectors:

Finally, other specialty property sectors such as data centers, cell towers, prisons and storage are less affected. We do not expect widespread rent collection issues from these properties. We currently hold three specialty REITs in our Portfolio.

Bottom Line: Some Rents are Delayed, But Most Will Get Paid

In the end, this is mostly a temporary issue for companies with strong balance sheets and enough liquidity to weather the crisis.

Some companies will be more affected than others (example: EPR Properties (EPR)) but ultimately, even they are expected to collect most rents in the back end and return to normal as we put the crisis behind us.

You can expect to read a lot of negative headlines on missed rent payments as we enter the earnings season. It's important that you keep in mind that this is only a temporary issue and that missed payment does not mean that the rent is lost.

We believe that this is a once-in-a-decade opportunity to buy high-quality REITs at dirt cheap valuation due to the market's excessive short-term focus. In the coming years, we expect certain REITs to double or triple in value, and we are buying.

Analyst’s Disclosure: I am/we are long MPW; SRC; STOR; MAC; SPG; UMH; IRT; EPR;. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Robert Shriver Barnes]

There are a few things that make me feel like it's still a bit early to get into eREITs.

While of course it's impossible to time the market, historically every single bear market has a false rally before capitulation, and based on the huge disconnect between the market and the real world brick and mortar economy it seems like we're in the midst of such a false rally right now.

My other concerns are a bit more specific to the sector, especially the mall reits. I was just reading about the JC Penny bankruptcy plus Neiman Marcus, J. Crew, and True Religion. They're the first, but unlikely to be the last considering the massive unemployment numbers, drop in industrial output, etc.. In addition, it seems like there is starting to be a move away from fixed rents. In a May 5th article in the WSJ, "Fixed Rent Payments Could Be the Latest Pandemic Victim," it mentions that:
"A number of retailers are already asking landlords to waive some of their rent in return for a share of future revenues. Ross Stores Inc. said last month that it would pay a rent equivalent to 2% of sales when its stores reopen. Guesst, a New York-based technology company, recently launched software to help retailers and landlords manage revenue-sharing arrangements."
It seem like it might be worth waiting a bit to see how all this shakes out.

Another short term concern is housing REITs. According to an article in the WSJ on May 1st, "Fannie Mae Income Drops as More Homeowners Suspend Mortgage Payments":

"More than 1 million borrowers are already missing payments, representing about 7% of the single-family loans it guarantees, Fannie said Friday. That figure is expected to double to 15% in the coming months as people lose jobs and incomes as a result of coronavirus-related lockdowns."

While that's not directly relevant to eREITs, it shows a general trend and while people do have to have someplace to live, it seems like there could be a significant wave of people unable to pay for multiple months who will eventually have to be evicted. Obviously they'll find someplace else to live, but their original landlords will end up with a write off more than likely.

While I'm definitely interested in getting into eREITs in the near future, I just want to play devil's advocate and try and think what can go wrong also.

[Jussi Askola]

Trying to time the market is not a game that you can win.

Most REITs are down 30-60% and are incredibly cheap. In fact, these are the lowest valuations in 10 years. Whether this is the bottom or not is irrelevant and impossible to know. Long term driven investors will do great at these prices and therefore, we are buying today: seekingalpha.com/...

[Swarandeep]

In industrial REITs, I think you mean prologis? Considering the photo of FedEx and their clietele having FedEx as a top tenant.

[Jussi Askola]

@Swarandeep Wrong guess :) We are buying a more discounted smaller industrial REIT: seekingalpha.com/...

[Swarandeep]

Do you think PLD is competent enough to maintain it's leadership even in the future? Any other thoughts about the same company/sector?

[Swarandeep]

😅 still a nice article!

[jeffspublicmail]

What’s you opinion on Mobile Home Park reits, I just read the New stimulus plan... “as many as 12 months of rent relief”. This could kill landlords. I’m worried and I only have 3 doors.....

[Jussi Askola]

I am bullish on them. Rent collection has remained strong. There is one of them in particular that we like at High Yield Landlord: seekingalpha.com/...

[Cantfixstupid]

Though I bought additional shares in three REITs during the race to the "so far" bottom, the selling seemed excessive due to uncertainty and fear. I felt neither. I am keeping the rest of my dry powder for next earnings season. Any future purchases will need more clarity before I commit to additional purchases. Right now I am long WPC, MPW and VER.

[Jussi Askola]

Well said. Thank you @Cantfixstupid
A lot of negativity, but results remain strong outside of retail and hotels. We are buying heavily at High Yield Landlord: seekingalpha.com/...

[lasse006]

Thanks a lot for your article 👍

[Herman Tai]

Which office reit does HYL hold today?

[Jussi Askola]

@Herman Tai We do not own any pure-play office REIT, but we are currently reviewing many potential opportunities that we will share soon: seekingalpha.com/...

BPY owns some office as part of its portfolio.

[22thoroughbred]

You’re continuing a miss-conception that I’ve heard for 6-8 weeks, the idea: “However, they are not immune either. The operators of these properties are under severe financial stress due to delays in more lucrative surgeries as they must make space for coronavirus patients.”
Is not accurate, yes many elective type procedures are being moved back to June/July the reimbursement rate for COVID cases is huge, that’s 1 reason so many deaths have been “ COVID related” those 2 words increases reimbursements by $19,000 per case, AND hospitals are being paid for every COVID case they treat unlike “normal” times when they must treat indigent patients and get ZERO for the efforts. The pandemic is taking a huge toll on people but the fees received offsets all of that and the elective surgeries will be back soon.

[Jussi Askola]

Thank you for sharing your thoughts, but it is not so simple, and a lot of hospitals are suffering great pain from the delays in elective surgeries. Some are filling for bankruptcy and many need additional help from the government.

[22thoroughbred]

Being the cynic I am, can you post a link to a possible hospital BK, I am actually curious...Thx

[Jussi Askola]

If you take 2 sec to google, you will find plenty of examples of hospitals that are struggling.

[Jack'sson]

@Jussi Askola Thanks for the facts. Even partial, they are much better than no information.

[Jussi Askola]

Thank you for your comment @Jack'sson

[Gary Kime]

Next up,
1. Full price offer for TCO.
2. Dividend cut
3. Horrible earnings!

[Jussi Askola]

TCO is being bought out.

[Gary Kime]

The above means TCO gets their full price which is negative for SPG. They bought at the top. I should have indicated that all three of the above comments come out of the SPG earnings call tonight.

[Jussi Askola]

They did not buy at the top. They bought after a multi year decline, but still far from the bottom. 10 years from now, I think that TCO will prove to have been a bargain for SPG. 6-7% cap for class A mixed use assets with enormous densification potential is a good deal in a 0% rate world.

[Gary Kime]

Jussi, I think long term you may be correct on the market leaders (I.e, SPG/TCO) but I think you are way too early. I predict tonight is the beginning of the next leg down after horrible news is reported by SPG. I think they might eventually break the current low.

I do however think they survive but if people are going to invest in retail either SPG or MAC you better have an iron belly because you haven’t pucked it up yet.IMO

Good luck. I like your style but I think some of it comes with being young?

[Jussi Askola]

We are always long term oriented and openly admit that we have no clue how the market will behave in the short run. We don't think anyone knows.

We are buying REITs at cents on the dollar. We expect enormous long term upside from these prices, and we are fine with the near volatility: seekingalpha.com/...

[jasonjones]

Many of the comments here are one of the reasons I won't write a SA article. Clearly this guy is trying to HELP you for free. He writes realistically about sectors and people slam him? It was a good article relevant to the times. I appreciate his efforts.

[Banker300]

Insightful article. What about shopping center REITs?

[Jussi Askola]

I forgot about those in this article. They would in between mall and net lease REITs. Rent collection is around 60%.

[Buyandhold 2012]

What to expect from rent payments?

Trouble in River City.

But out of the ash heap of trouble comes opportunity if you just know where to look.

[Jussi Askola]

Well said. Thank you for your comment.

[sadye]

I see a lot of unrealistic enthusiasm about the re opening . Sure, you say most of your reits are not retail, but retail effects a huge amount of these properties in one way or another. These new openings are only resulting in more loses for most businesses, and really there is no light in the tunnel at this time. Companies losing money and paying back rent? I don’t see that!

[Jussi Askola]

Look, I never said that this is a done deal in a few weeks from now. There is a lot of pain ahead, no doubt about it. The point is that one to two years from now, life will be fairly similar to pre-crisis. Yet, REITs are enormously discounted right now. Real estate should be valued based on decades of cash flow, not a few quarters. If you are long term oriented, this is a generational opportunity and we are buying: seekingalpha.com/...

Have some patience. We are landlords, not traders.

[littlebirds]

Informative article. It seems REIT stock price remain very choppy and much more volitile than the whole stock market, such as PEAK and CXW. Why is it?

[BryanMill$]

Interesting and highly relevant article, thank you.

[gadom11]

What is material here is what will be the long term vacancy rate. Overall America is overbuit in almost every sector. Or if not overbuilt improperly built (Amazon does not want your one floor warehouse 30,000 sq ft with a measly 32 ft clear height.). That may not be temporary. Even residential can be overbuit if people start sharing housing again.

Clearly some businesses will never reopen. Some malls that were on the edge will be pushed over the edge.

It could takes years for this to rightsize.
Vacancy rates will rise even in the best properties.
Long term yes you could do well. But if you are looking for consistency in income short term that might be a concern.

[Jussi Askola]

NOI growth trends of the past many years would disagree with your belief that all sectors are overbuilt. NOI growth is positive in an undersupplied market.

The near term demand will be volatile for retail, office, industrial and other cyclical sectors. As always, the key is to invest in properties that are in high demand: seekingalpha.com/...

[TagHoyer]

My take:

Commercial properties: The leases may say that the rent is due even if the business closes, however business interruption insurance for pandemics is generally not available. The businesses that go bankrupt will be authorized by the bankruptcy judge to abrogate the lease and those rent payments will not be paid.
As far as rents being paid in arrears for businesses that re-open, I would not count on it.

There will be downward pressure in rent rates in many markets, maybe most if not all especially commercial.

In residential, it is possible some people won't be able to make mortgage payments and will be forced into residential rental properties. This is a potential silver lining for REITs, albeit a horrible one for individuals and bad for communities, as well as the prices of homes; investors should be able to find bargains, however this is not all good.

In terms of self storage, this is a very weird asset. Price increases have already been deferred at Public Storage according to another posting on Seeking Alpha. In my community, I have noticed that there are deals for self storage that were not available before, and there is discounting due to current circumstances and perhaps some overbuilding. Unlike residential or commercial, if you don't pay the rent, you lose your belongings without a prolonged eviction process, so there is some floor (no pun intended) to rent payments.

However, in a sense, none of the above matters as much as to what extent has the market, the prices of REITs discounted or not discounted the above. My own view is that there is too much complacency, and I am waiting for prices of REITs to fall more. Others may feel that REIT prices have fallen too low for the circumstances. I actually have recently sold about ten percent of my REIT positions after the recent market snap back, increase.

REITs are a unique asset class, and historically have been very good investments; for tax sheltered accounts, they are particularly enviable. They are less labor intensive than many industries, and many REITS are by themselves diversified having many different tenants, often in varying sectors. However, REITs are no longer a sleepy investment and have been discovered by the public, and this past advantage may have been arbitraged away.

[Jussi Askola]

Thank you for sharing. I agree that retail will face the most struggles. I would only invest in high quality properties, which enjoy better bargaining power with tenants.

Concerning other property sectors, I am not too worried about rent payments. 90% of REITs are not retail-based. It is important to remember that.

[metameta]

I don't get the confidence in 'we won't cancel rent we defer it' ok that looks strong keeps contract intact,etc.. but it materially weakens your tenants.

If they are LLC's with no personal guarantees I feel this overconfidence could come back to bite landlords who let debt pile up on tenants balance sheets with no way to earn back forever lost revenue.

what happens in 12 months when the 20% of tenants who 'defer' just file BK instead? confidently 'defer' all you want it seems arrogant to me i think broke tenants will say forget it, file bk, and start over. bk is the ultimate stop loss in a tenant/landlord relationship.

btw i am speaking as an owner of a small drive thru restaurant property. they came out asking for 50% haircut in rent I asked for sales. they paid in full no call back. i am wiling to be flexible and match lost sales volume to mirror rent adjustments but just saying 'f*** you pay me' seems off to me.

[Jussi Askola]

We are talking about a few months of rents. It does not "materially change" the long term prospects of the tenants or the landlords.

I think that most people are overreacting here. I agree retail has pain ahead. But that's small fraction of REITs. Most companies we are buying enjoy near 100% rent collection: seekingalpha.com/...

[jasonjones]

Wow! You sound like a real nice guy

[MEBH Investment]

We are invested significantly in MAC at sub 10 levels. Expecting an “opening” bump in the coming weeks. The water is certainly murky in this environment but we feel the investment opportunity outweighs the risk.

[Jussi Askola]

@MEBH Investment Thank you for sharing. I have no clue about short term performance, but very bullish on the long term prospects.

Feel free to join us for a free trial to read our comparison of MAC and GGP: seekingalpha.com/...

It is very relevant to today's situation.

[Other Side Of Trade]

The author has left out the category of REITs most likely to encounter rent deferral requests--shopping centers, which at best are collecting 60% of rents. FRT has stated that unpaid rent will indicate to them that the tenant needs to be replaced with a stronger or more ethical business. Good policy, but short term pain. The ultimate problem with BRX, KIM and others is the probability that up to 50% of small businesses will not survive, especially if a long recession occurs. Filling those empty spots will take some time.

[Jussi Askola]

Outside of retail, most REITs are collecting 95-100% right now.
And when it comes to retail, I expect high quality companies such as FRT to collect most deferrals and return to normal fairly quickly.