COVID-19 impact on Retail Real Estate

Prolonged mall closure, rent waivers to test financial flexibility of mall operators; operating income to decline by 45-60% in FY2021: ICRA
  • The impact on key financial metrics like net operating income and debt service coverage indicators will be acute in FY2021 due to the rent waivers. It will vary based on revenue share, cost optimisation and leverage levels
  • As malls have started opening gradually across the country, the terms between the mall operators and retailers are being revisited, broadly mall operators are agreeing to let go of the rents anywhere between 50% to 100% during the lockdown period
The increasing spread of the Covid-19 pandemic in India, starting from mid-March 2020 and the resultant preventive measures taken by the Central and various state governments have severely affected retail mall operations. As per ICRA Research, the mall operators have been significantly impacted due to the closure of operations for around three months. Over the last few weeks, though malls in some cities have resumed operations, properties in some of the metros and tier-I cities are yet to resume due to the severity of the pandemic in the respective geographies. These markets are economically critical and uncertainty about opening malls in these geographies may hurt the players present in these markets.

Mall operators generate almost complete income from the lease rentals received by the tenants. The retailers have been severely impacted and revenues for most of them have been reduced to zero during the closure period. Rental expenses form a sizeable share of the 12-16% of the revenues for retailers, therefore, in line with expectations, the tenants have been negotiating with the mall operators for a waiver or rebate on the rentals. ICRA notes that the mall operators and tenants are long-term business partners with lease tenures of up to 30 years in some cases. A disruption of three to six months is a relatively small period and hence both parties are willing to resolve the issues.

Commenting further, Mr. Anand Kulkarni, Assistant Vice President and Associate Head – Corporate Ratings, ICRA, says, “We have been highlighting the possible stress on retail real estate operators. The contagion fears as well as the possible impact on disposable income of the consumers will lead to low footfalls in malls throughout the year. Further, people may fulfil their shopping requirements through e-commerce platforms or through local retailers in the near term, which may also impact the footfalls. In such a scenario most of the leveraged malls will have to take measures to fund the cash flow mismatches which are expected in the current year.”

As on date, some malls have opened up while others are on the verge of opening; therefore, the stakeholders are in the final stages of discussion. A few mall operators have announced blanket deals for tenants in their properties, which include a waiver of the minimum guarantee rentals for the lockdown period. Other operators are still in one-to-one discussions with tenants and customised deals are being worked out for tenants. Broadly the mall operators are agreeing to let go of the rents anywhere between 50% to 100% during the lockdown period and the quantum depends on the balance sheet strength of the mall operator, the competitive advantage of the property and the bargaining power of the retailer. The mall operators, recognising a possible weakness in the performance of the retailers even after resumption, are offering a staggered reduction in discounts over the next two to three quarters. At the same time, the operators are also imposing terms like no near-term lease terminations and increased revenue share component for the residual period of FY2021. The current terms are being worked out with eligible tenants like anchor and vanilla retail stores. However, tenants like multiplexes, restaurants and family entertainment centres are still not allowed to open in many places and those terms are likely to be worked out separately.

ICRA expects the cash flows of malls in FY2021 to get significantly impacted due to the discounts being offered to the tenants in the minimum guarantee rentals. Further, the revenue share income is likely to be depressed throughout the year. It is estimated that the impact on key financial metrics like net operating income and debt service coverage indicators will be acute due to the rent waivers. It will vary based on revenue share, cost optimisation and leverage levels.

Exhibit 1: Reduction/deterioration in FY2021 key financial parameters of a typical mall (pre-Covid DSCR and DSCR including one quarter DSRA of 1.22x and 1.47x respectively):
    Scenario 1# Scenario 2##
    Net Operating Income (% reduction) DSCR (times) DSCR Including 1Q DSRA (times) Net Operating Income (% reduction) DSCR (times) DSCR Including 1Q DSRA (times)
Pre-Covid Revenue Share (% of NOI) 5% 53% 0.64 0.92 46% 0.77 1.05
10% 56% 0.59 0.87 49% 0.71 1.00
15% 59% 0.55 0.83 52% 0.66 0.94
The percentage in Net Operating Income indicates decline with respect to the pre-Covid scenario
# - Scenario 1: Assuming complete MG waiver for 3 months followed by gradual reduction in waiver for the next 3 quarters
## - Scenario 2: Assuming 75% MG waiver for 3 months followed by gradual reduction in waiver for the next 3 quarters
Net Operating Income – Minimum guarantee rent + Revenue share rent + CAM profits
DSCR – Assuming complete interest obligations and 7 months of principal obligations for FY2021
DSCR Including 1Q DSRA – Assuming 3 months of fund-based debt service reserve account and no additional liquidity
As illustrated above, the credit metrics of mall operators are likely to weaken substantially. Furthermore, the rental payments from tenants are likely to lack discipline throughout the year and hence a healthy balance sheet liquidity will be essential. ICRA notes that some of the vanilla or standalone retailers might not be able to resume operations even after the rental waivers due to weakening of their financial position. More than normal vacancy during FY2021 due to the same will pose a downside risk to the estimates.

“ICRA has been emphasising on the importance of liquidity, parentage and financial flexibility of mall operators. We believe that the lenders will play a critical role by supporting the mall operators and revisiting the repayment terms. Capitalisation of accrued interest, sanction of new debt facilities and extension in the repayment schedule will be some of the means through which the immediate impact on debt servicing can be mitigated. Hence, players with healthy financial flexibility will be able to mitigate the risks more effectively. Additionally, entities with strong parentage will be better placed to receive promoter’s support to fund the deficit. Some players with diversified assets – apart from the retail segment on the balance sheet – will also be able to sail through the crisis comparatively better than the companies with standalone assets”, added Kulkarni.

Though the long-term prospects for the organised retail sector are expected to be healthy, managing the near-term crisis will be critical for the mall operators. However, a waiver for a period of three to six months will not have a significant impact on the long-term credit profile of the mall developers. Any extended underperformance, a new phase of long lockdown or significant vacancy due to weakness in retailers’ financial position will pose a downside risk for the industry.

The possibility of a structural shift towards a greater number of pure revenue-sharing agreements will be the key monitorable going forward. The lease rental discounting loans, currently availed by the mall operators, factor in a stable revenue stream in the form of a minimum guarantee rent. The loans have long amortisation schedules, typically ranging between 9 to 15 years with fixed monthly repayment schedules. In case of a shift towards the pure revenue-share model for a large number of tenants, the volatility in revenues of mall operators will be extreme in line with the revenue performance of the retailers. Further, the mall operators will face event-linked deep downside risks in future. Resultantly, the lenders may need to redesign the lending and amortisation terms for loans given to the sector in case of a material increase in pure revenue share tenants.

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