As luxury stores remain shuttered, the pandemic and economic fallout are sparking a rift among owners of residential and retail property in one of the country’s top real estate markets.
For many condominium and co-op buildings in Manhattan, Brooklyn and Queens, adding spaces for retail tenants was good business. But as one of the toughest years in decades comes to a close, many of the cafes, gyms and shops in those spaces are struggling to pay rent or have shut down until further notice.
Because of these delinquent retail tenants, condo and co-op owners are seeing their dues rise and the value of their homes sink.
“It used to be that having a commercial unit was a boon to the residential units,” said Leni Morrison Cummins, a New York real estate attorney at Cozen O’Connor. “Coronavirus has sort of shifted that paradigm.”
When shops anchoring residential buildings stopped paying rent to their commercial landlords, the landlords in turn stopped paying dues to condo and co-op boards. Those buildings — new developments in particular — might have relied on that income to cover up to 15 percent of their annual budgets.
“If you have 15 percent of the building not paying, that means the other 85 percent has to pick that up,” Morrison Cummins noted.
The pain is compounded for any homeowners or developers trying to sell units.
“When someone goes to sell their unit, one of the questions is: ‘What’s the current common charges?’ If you have a higher number than the rest of the market, it’s going to certainly lower the property values,” Morrison Cummins said.
The attorney said she saw a significant increase in liens placed against commercial units by condo and co-op boards over the summer. Some are now turning into full-blown foreclosure suits.
Last month, the board of the Bel Canto Condominium on the Upper West Side sued to foreclose on liens totaling more than $55,000 worth of common charges unpaid by retail kings Ashkenazy Acquisition and the Gindi family, the owners of four commercial units. If those commercial fees have to be borne by the building’s 75 homeowners, that would be $740 each.
Veteran residential brokers say it’s no surprise to see condo and co-op boards taking aggressive positions against investors in the courts.
In some cases, they “have to take quick action because if the bank goes to foreclose” on the owner of the retail space, the building’s residents might not get their fair share, said Steven Goldschmidt, a longtime broker with Warburg Realty.
Red flags
The first signs of trouble came at the height of summer when two properties made an unusual appearance in DBRS Morningstar’s weekly commentary on the troubled commercial mortgage-backed securities market.
Since March, most of the properties flagged by the rating agency have been shopping malls and hotels around the country. But in early August, retail condos at the base of two Manhattan residential buildings made Morningstar’s list.
If you have 15 percent of the building not paying, that means the other 85 percent has to pick that up. — Leni Morrison Cummins, Cozen O’Connor
One of the commercial units is at the base of the 18-story Wellington Tower on the Upper East Side. The bulk of the building is residential condos that sold for between $720,000 and $2 million last year, but its ground-floor commercial unit is the collateral for a $30 million securitized loan.
The retail space’s occupancy fell 36 percent in March after a doctor’s office vacated the space two years before its lease expired. Adding to the concern, Morningstar noted, the condo’s largest commercial tenant, a parking garage, is operating on a month-to-month basis. Parking facilities in Manhattan have taken a beating since offices emptied out and theaters, restaurants and museums closed or pared back.
Though the rating agency said the building’s location on East 82nd Street was strong, “the lag may be noticed amid the economic slowdown caused by the coronavirus pandemic.”
The second loan was on a commercial unit at the base of an eight-story Noho residential condo building at 50 Bond Street, where full-floor lofts have sold for up to $7 million.
The 6,400-square-foot space, which had been occupied by Lululemon until this fall, serves as collateral for an $8.5 million loan that accounts for 1 percent of a larger CMBS pool. Lululemon announced its departure two years early using a fee-free termination option. And while the loan is current, Morningstar noted that it has been delinquent on more than one occasion in the past and that re-leasing the space would likely be difficult.
The two properties are examples of a growing trend that affects commercial landlords and homeowners alike.
David Putro, a senior vice president at Morningstar who tracks CMBS deals, said the rising number of delinquent loans on single-tenant retail properties in New York “is not something that has occurred regularly in recent history,” though he stopped short of calling it a trend.
And while single-tenant retail properties are often found at the base of residential buildings throughout the city, solid data is sparse.
Jacob Klein, an investor in retail properties in New York, New Jersey and Pennsylvania, owns eight commercial condos in Manhattan, all at the base of residential buildings. One of his best-known is the Trader Joe’s at 670 Columbus Avenue.
Klein said he was not searching for retail units in residential buildings as a strategy, but that’s where most of the city’s well-positioned space is, given the lack of desirability of living on street level in New York and the longstanding belief that the most lucrative use is retail. Commercial rents had been seen as a steady stream of income for buildings.
For residents who own shares in co-op buildings with one or more retail units, the board can act as the landlord for the commercial tenants. The rent often goes toward paying off the building’s mortgage.
In other cases, outside investors can be left holding the bag if a commercial space remains shuttered.
By the end of August some 330 co-op buildings in the New York metro area with securitized commercial mortgages were on Trepp’s watchlist. Those loans, although nearly all current at the time, were flagged by the CMBS data firm based on various performance triggers such as delinquency, pending maturity, occupancy rates and major tenant financial issues, according to Trepp spokesperson Hayley Keen.
Morningstar’s Putro noted that weakness in securitized commercial loans — including those being sent to special servicing — has been occurring equally among national chains, boutique stores and mom-and-pop shops. And while New York’s three-month shutdown certainly did not help, he attributed the city’s retail sector woes to more systemic issues, such as extremely high rents that pre-date Covid-19.
Asking rents for Manhattan retail space have fallen to a nine-year low, with the pandemic exacerbating their downward spiral, according to a CBRE report. The average asking rent across 16 of the borough’s most active retail corridors was $659 per square foot last quarter, down nearly 13 percent year-over-year. Leasing volume for the first nine months of 2020 was down about a third from the same period last year.
Putro said two broader concerns are “what direction do retail rents go in?” and “how does some of this space get backfilled longer-term?”
Blood in the water
For homeowners, the biggest question is how much will they be out-of-pocket, if payments stop coming from retail units?
Though condos grab far more headlines on New York real estate stories, advisers for residential boards say co-ops that rely on commercial income are getting hit hardest.
“If the commercial tenant is not paying, then the corporation [effectively, all the co-op owners] must make up the entire shortfall,” wrote Jonathan Canter, a partner at Kramer Levin Naftalis & Frankel focused on condos and co-ops, in an email.
“So a default could threaten a double hit to the residents — having to carry the commercial space’s share of the building’s taxes and the loss of income that may be keeping monthly expenses affordable,” Canter added.
Jim Goldstick, a vice president at the property management firm Charles H. Greenthal, said that among the co-ops he advises that have lost commercial income during the pandemic, the increase in out-of-pocket costs for shareholders is 10 percent to 20 percent. Goldstick said he’s encouraging those co-ops to make up for their budget shortfalls through assessments, rather than increasing maintenance, which is a more permanent levy.
According to Goldstick, co-ops with commercial space usually fall into one of three categories: there’s a master lease that puts the financial liability on an outside investor; the co-op board acts as the commercial landlord; or they’re bundled into condops, co-op buildings where commercial spaces are sold as condo units.
Goldstick said the number of co-ops feeling direct impact from shuttered retail spaces are relatively few.
But for Maxwell-Kates, which manages co-ops with commercial tenants in the Flatiron District, in Midtown East and on the Upper East and Upper West Side, the loss of steady retail income has prompted a 50 percent increase in the number of buildings refinancing their mortgages, said CEO Max Freedman.
“The only other option is to put through an assessment, which is very painful, especially during this time,” he said, noting that the typical methods of charging buyers for storage space and gym memberships had been blocked due to the pandemic, as of late August. Though only about a quarter of the buildings Maxwell-Kates manages rely on retail income, Freedman said he recognized the immediate issue that beleaguered stores and restaurateurs would have on them.
“It was very concerning,” he said. “Without retail tenants … it trickles down and it adversely affects everyone else in the building.”
Freedman recalled one co-op where commercial rent accounted for about 30 percent of the building’s budget.
Of the property’s five retail tenants, only one, a liquor store, remained open after the pandemic hit. In that case, the board successfully applied for three months of mortgage relief from its lender. For its four shuttered tenants, the board agreed to reduce rent for April, May and June and defer the balance of rent owed.
Attorney Mark Hakim has represented co-op boards on similar cases. He said the emphasis is on negotiating an agreement with retail tenants because the last thing any board wants is a vacancy and no income.
“How quickly are you going to get a new diner in there, for God’s sake? That space will sit vacant for years,” Hakim said. “If you’re a co-op, find a way to work with them.”
He noted that some boards must get lease amendments cleared with their mortgage lender, but in most cases lenders have been accommodating.
“Most buildings don’t necessarily have these deep pockets,” he said. “Co-ops and condos are not in the business of profiting, not in the business of building up these large reserves.”
You walk up to the building and there’s a huge vacant space. It looks a little scary and it raises a red flag. — Michael J. Franco, Compass
In fact, prior to 2007, co-ops were not allowed to have more than 20 percent of cash flow come from retail tenants. A change to the law was sought for years by organizations representing co-ops, particularly those with prime retail space that had to accept below-market retail rents to stay on the right side of the law. After the law changed, more buildings began to ease costs for shareholders by leasing retail space.
But now that the retail is stumbling, those costs will spill over to apartment owners and investors alike.
“That’s where the dominoes start to fall,” Hakim noted.
A caution for buyers?
Compass broker Michael J. Franco said vacant retail space is a huge stumbling block for prospective buyers regardless of whether it’s a condo or co-op.
Franco said he has noticed that buyer concerns over vacant retail have increased since the pandemic hit, he believes because the state of the city’s commercial real estate is top of mind for many.
“You walk up to the building and there’s a huge vacant space,” he said. “It looks a little scary and it raises a red flag. I think in New York City in general, it gives people a negative impression.”
Goldstick said steps can be taken to prevent that.
“There are ways to make an empty storefront look presentable,” he said, such as making sure they are tidy and have clear signage displayed.
“An empty store that’s clean is not an eyesore,” Goldstick argued. But he acknowledged that there are “empty stores all over Manhattan.”