Retail turmoil unleashed by COVID-19 has made its way to landlords. 

Two mall operators, PREIT and CBL & Associates Properties, filed for bankruptcy within 24 hours of each other. While neither Chapter 11 comes as a surprise, they both serve as a reminder that the financial stress in the industry is deep and spread among stakeholders in the retail industry. 

Berkeley Research Group's Mark Renzi, an adviser to CBL, noted in court papers that so far this year, more than 30 of the company's retail tenants have filed for bankruptcy, many of them closing stores. Many others have worked out rent deferrals and other concessions with CBL. 

COVID-19 sparked possibly the largest wave of retail bankruptcies in a decade, after years of declining foot traffic at malls, and shifting consumer and competitive dynamics have forced dozens of other retailers into bankruptcy and still others to pare their store portfolios. 

That, obviously, represents a major hit to rental revenue. Two major retailers in bankruptcy, J.C. Penney and Ascena, together account for $18.5 million in yearly revenue for CBL and lease 6.1 million square feet of store space from the company, according to Renzi. Ten other bankrupt tenants account for another $22.3 million in revenue. 

Others have skipped rent or negotiated deferrals as the spring closures and continued traffic declines had a massive impact on revenue for discretionary retailers. Renzi said that by Sept. 30, CBL logged $50.2 million in potentially uncollectible revenue. 

PREIT, too, has taken major hits to revenue amid retail's pandemic turmoil. Through the second quarter, PREIT had received 53% of due rent payments, which was actually slightly above the average for mall real estate investment trusts, according to Jefferies data. The company's Q2 revenue was down around 30% year over year. 

Active negotiations with tenants could bring more abatements and deferrals in 2020, and another COVID-19 wave in the U.S. could add more financial pressure, Renzi said of CBL. 

Financial upheaval

The trouble of REITs exposes the deeply interconnected relationships among retailers, their landlords and banks. 

While some retailers and restaurant chains took advantage of federal stimulus dollars, stakeholders have largely been left on their own without a policy solution to figure out how to navigate a major financial crisis for the industry. Proposals with industry support like a national insurance program, which could protect retailers against revenue disruptions, never materialized. 

That has left parties, and bankruptcy courts, to negotiate what to do about retail rents to landlords and landlord payments to their lenders. 

CBL and PREIT individually worked out their own solutions. Both entered bankruptcy with pre-negotiated plans. PREIT said in a press release that it had a deal with 95% of voting lenders that provides an additional $150 million to recapitalize its business and extend its debt maturity schedule. 

As it tried to negotiate an out-of-court deal, PREIT signaled that it could have to file for Chapter 11 if it didn't win enough lender support, and in fact its main bank lender alleged the company was in default for not filing for bankruptcy by an October deadline outlined in an earlier agreement. 

In court papers, CFO Mario Ventresca said the deal was designed to "provide much-needed liquidity to allow the Company additional time to navigate the uncertain months ahead."  

CBL announced a deal with lenders this summer that would require it to file for bankruptcy this fall, after earlier missing bond payments. CBL CEO Stephen Lebovitz said in a Monday press release that the plan would allow the company to eliminate $1.5 billion in unsecured debt and and other obligations. 

CBL's board and management "firmly believe that implementing the comprehensive restructuring …  through a Chapter 11 voluntary bankruptcy filing will provide CBL with the best plan to emerge as a stronger and more stable company," Lebovitz said. 

'More standoffs coming'

While COVID-19 brought a major disruption, both REITs, and mall operators in general have experienced deep struggles that long precede the pandemic. 

PREIT's revenue has fallen for each of the past four years leading up to its bankruptcy, as major anchors like Sears, J.C. Penney and Macy's have closed stores and mall retail in general has retrenched.

CBL meanwhile is concentrated in middle markets and middle malls which have struggled of late. The REIT has been in slow-motion decline for years, much like many of the retailers at its malls. Top tenants, including L Brands and Signet, have plans to collectively close hundreds of stores. Others have through bankruptcy or are in perpetual turnaround mode. 

Renzi noted that the company's financial performance has been declining, with a $131.7 million loss in 2019 on top of a $99.2 million decline in the prior year. COVID-19 has exacerbated many of the trends leading those losses, such as consumer shifts to online, discount and mass merchant retailers. 

Those trends have caused particular pain for department stores and apparel retailers, which are the backbones of many malls. Earlier this year, Green Street Advisors predicted that more than half of mall-based department stores could close by the end of 2021. Morgan Stanley analysts wrote in a recent research note that 43% of malls previously deemed "Jewels" have declined along the quality spectrum. 

Moreover, the turmoil in retail is likely to keep the problems between mall landlords and their tenants in the foreground. 

"Facing permanent margin impairment, retailers that have avoided bankruptcy filings are radically rethinking overbuilt store footprints, taking the innate tension between landlords and retailers to a new level," the Morgan Stanley analysts wrote. Their research indicates that U.S. malls are up to 35% over-stored while strips are over-stored by up to 15%.

"We see more standoffs coming in rent negotiations, with multiple potential outcomes for mall landlords and retailer tenants," including retailer bankruptcies and lease exits or modifications, the analysts wrote. 

The accelerated closures and bankruptcies in retail have prompted some landlords to take direct action by buying some of those retailers out of bankruptcy to protect their malls. Simon Property Group has perhaps been most active on that front, teaming up with Brookfield Asset Management to buy Forever 21 in February and to cut a deal for J.C. Penney more recently, among other deals. 

CBL and PREIT, with their stressed finances, lack the resources for those kinds of stopgaps and in fact are themselves now in bankruptcy.

Both companies have an orderly path out of Chapter 11. Once out, both companies, and their peers, will still have to contend with protracted uncertainty in a retail market defined by change and the pandemic.