On Credit
July 15, 2020
“I used to pay my tailor a hundred pounds a year just to keep him quiet. So he wouldn’t send me any bills. Frightful blow to him when I went bankrupt.”
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”
-The Sun Also Rises
Happy Summer! I hope you have managed some sort of vacation with (tiny groups of) friends and family. I apologize for not getting a note out last month, and greatly appreciate those of you who actually noticed.
I think it’s time to talk about credit. Over the last thirty years as retail leases have gotten longer and retail spaces bigger, the idea of retail tenant credit has become a pathological preoccupation for many owners. The three concepts are closely related, but let’s start with credit.
Specifically, let’s start on Monday October 12th, 1987. Fatal Attraction grosses $10.5M that Columbus Day weekend. Here I Go Again is #1 on the Billboard charts and in constant rotation on MTV. Bob Barker has just stopped dying his hair (and gets a one minute standing ovation for it). Also that day the 30-year US Treasury closes at 10.24%
But all good things must end. Fatal Attraction would be nominated for six Oscars but win none. Tawny Kitaen would be indicted in 2002 for abusing her husband. Even Dorian Gray’s cousin Bob Barker would eventually retire in 2017. More immediately, on the following Monday October 19th, the stock market would crash, losing 20% in one day. We didn’t know it at the time, but interest rates would also never again approach the highs of 1987.
Section 37 Credit Guaranty: Tenant hereby guarantees to Landlord that it will hold on to the Premises for the rest of its days.
By the early 1990s, with stocks in a long bear market and interest rates in slow decline, pension funds found themselves increasingly underwater on their obligations. With their scars from the 80s real estate crash fading they returned to commercial property, finding better-than-bond-like returns for what they claimed were practically-bond-like risks. In the years since pension funds, life companies and sovereign wealth outfits invested hundreds of millions and then billions and then trillions— not just in retail but in all types of real estate— looking for steady, set-it-and-forget-it type returns.*
*It is estimated that pension funds, life companies, sovereign wealth funds and other institutional buyers collectively own one third of all commercial real estate in the world.
As institutional investors kept looking for more credit tenant retail to buy, we in the retail development world, being good capitalists, gladly kept building. Along the way we figured out something interesting. Turns out that the only thing more valuable to an institutional buyer than a national tenant occupying 10,000 sf is one in 20,000 sf (size). And the only thing more valuable than a national tenant leasing 20,000 sf for ten years is one who will lease it for fifteen (time). And when you’re a national retailer who’s promised your shareholders you’d double your store count, well. . . you gotta do what you gotta do.
In this way lies madness.
When you invest hundreds of billions of dollars of widows’ and retirees’ money into retail real estate — with cash flow backed by leases backed by the credit of the lessors— you tend to care a great deal about credit. Or at least, the appearance of credit. It will become a monomania. An idée fixe. A mantra you chant at night to keep the auditors away.
But here’s the thing: there is no such thing as retail tenant credit. Maybe there was twenty years ago, but not anymore. Like many things, Covid laid bare all of the many fault lines that ran through the concept. “Credit” retailer after “credit” retailer is going bankrupt, many never to return, and Covid isn’t the reason. There is no alternate universe without Covid where JC Penney and Stein Mart and CBL and all of their competitors don’t go bankrupt. They’ve been gradually going bankrupt for years: Covid just made them do it suddenly and all at once.
How was the investment committee supposed to know that Pier One was going bankrupt? They’re a credit tenant!
There is no such thing as credit in retail world because retail world is changing too fast, and most large (read: credit) retailers are too bureaucratic to keep up . Globalization and technology and demographics and the rise of China have pushed the pace of change to levels that the old-fashioned credit lease regime isn’t equipped to handle. The twenty largest retailers in 2000? Only seven are going concerns today. The twenty largest retailers in 2040? I bet half of them don’t exist yet.
What about publicly traded retailers? Woolworth’s was on the Dow Jones a year before it shuttered. Iconic? Brooks Brothers was iconic. So was J Crew. Unique? Nieman Marcus. Internet Proof? Mattress Firm. Grocers can’t go out of business, right? About a thousand have. For every well-capitalized grocery store there are ten broke ones, plus another twenty janky department stores still trying to sell polyester pantsuits to a missing middle class and a hundred beleaguered chain retailers loaded up on too much PE debt.
The national tenants who really do have money also really do have attorneys. Nobody wants to pay the landlord when times are good, and what national retailer is going to let a good crisis go to waste? How do you think those tenants got all that money in the first place? Not by just giving it away because some lease somewhere said to. Sheesh.
So I’ve got a pretty good force majeure clause and a team full of high-powered attorneys going for me. You know. Which is nice.
What is the path forward for retail? There are several possibilities. Over the next few notes I will argue that one answer is fungibility. Fungibility is the opposite of credit, and it may be the best way out of this retail mess we’ve made. But changing from credit to fungibility will require a fair amount of pain and a lot of trade-offs, mostly involving space (size) and time.
Change will also require developers and owners to understand the underlying retail businesses better, as well as frankly running some of them ourselves. It won’t happen all at once or even everywhere, but the world of retail real estate is going to look dramatically different in a decade. Internet startups and US Marines say to move fast and break things; our hidebound retail industry had better start doing the same.
I promise: the institutional investors are going to love it.
What We’re Working On. We are expanding! Our love of California is well-known, so I’m pleased to announce that we have just opened an outpost in Los Angeles. We’ll be doing all the same work out there that we do on the East Coast: retail strategy, design, operations, leasing oversight, development and more.
Back at Atlanta HQ, we are also hiring. Real estate experience is fine but what we really love are highly creative folks with deep backgrounds in retailing, events and F+B. If you know someone who might be a fit, please tell them to reach out here.
What We’re Reading
The Wreck of the Penn Central. Epic business failures aren’t only in retail. In 1968 the Pennsylvania and New York Central railroads signed the largest merger in U.S. history. It went so badly that trains couldn’t be routed on each other’s rails. Cars were lost; no one knew how many there were. Desperate plans were made to sell Grand Central to developers. Two years later the renamed Penn Central went bankrupt, the largest for 31 years until Enron’s.
What We’re Eating
The best news by far to come out of the shutdown in Atlanta is Bomb Biscuits’ Biscuit Box delivery. For those not familiar, Erika Council has been making some of the best biscuits, beignets and sweet rolls in the country as an occasional pop-up. Now you can get these delicious baked goods delivered every weekend but be warned: she sells out within an hour every time she posts the menu. So you’d better act fast.
What We’re Listening To
I grew up on 80s metal. I studied international relations in college. So maybe it’s just me, but any podcast that features both George HW Bush and Mötley Crüe is a podcast I can’t turn down. You owe it to yourself to listen to this excellent one that asks: could the CIA have written a power ballad for a German hair band to insert into the Soviet Union and with it end the Cold War?
As always, thanks for reading! If you’re getting this for the first time and want to sign up, just send us an email.
Please drop us a line if you’ve got any interesting projects we can work on together; just don’t ask us to bring any national chain retailers along when we do. . .
Cheers,
G