2020: 2008 Except Worse

There is a tsunami coming to commercial real estate: mounting financial obligations with no ability to pay in full. State-mandated, short-term moratoria on evictions and foreclosures do not solve the problem. Here’s the good news: the Federal Government can solve the problem with a practical approach that requires very limited financial expenditures.

First, let’s face reality. For both office and retail tenants, the utility of office and retail space has changed for the foreseeable future (until there is a vaccine). Even then, business executives have learned that a lot of work previously done in an office can be done from home and those executives will shed space, much in the same way that technology advances led them to shed workers since the mid-1990’s. Fear and regulation will make discretionary retail virtually unprofitable until there is a vaccine and thereafter brick and mortar retail will have to offer a different and, more costly, value proposition to offset the convenience of online shopping. Amazon is here; Amazon is everywhere; Amazon is not going away.

In the short term, cash flow shortfalls will drive office and retail tenants to try to void their lease obligations. Currently, big box retailers like Victoria Secret and Bed, Bath and Beyond are litigating to end their NYC leases. While the NY courts (and many other jurisdictions) are not amenable to impossibility and frustration of purpose arguments, these cases are just precursors to lease defaults and tenant bankruptcies. Moreover, asset managers of huge swaths of commercial and retail properties simply do not have the discretion or authority to renegotiate leases to address the current circumstances. If a tenants do not have the cash flow to pay rent in full, evictions will follow as well damage actions for lost rent. In these circumstances, bankruptcy filings by commercial and retail tenants become a question of “when” and not “if.”

For now, these issues are being postponed in part by state moratoria on evictions and foreclosures — but that is about to end. Jump forward and multiply these lease defaults by the thousands, and then mortgage defaults by building owners who are not collecting rent, and you can see the problem that mortgage lenders will have. In 2008, the government stepped in to save the banking and financial services industries because the entire…