Heading into 2020, investors were hopeful that Pennsylvania Real Estate Investment Trust (NYSE: PEI), or PREIT, as it is commonly known, was on the right track. Over the prior several years, management had taken steps to offload its least attractive properties so it could focus on its best malls and was making progress on getting its balance sheet in order via improved rents and ongoing land sales.
Then the coronavirus pandemic happened. As a result, the REIT -- real estate investment trust -- is facing the worst operating environment retail property owners have faced in decades. As of May 25, only five of its 21 properties were opened, and the company had only collected 45% of outstanding April and May rents as of May 21.
As things stand today, the company is troubled. As more of its retail tenants face their own financial struggles, the third law of plumbing (you-know-what runs downhill) could take a big bite out of PREIT's cash flows as the year continues. If that proves true, the company will default on its debt obligations. If that happens, the company will almost certainly have to go through bankruptcy, wiping out shareholders in the process.
PREIT's biggest problem
On March 30, the company entered into an amendment of its credit agreement with lenders, which will provided it with "certain debt covenant relief" through September 30. At this stage in the coronavirus crisis, it was expected that a short-term shutdown would cause most retail to close down temporarily but that things would recover very quickly and PREIT and other retail-related companies would bounce back.
Fast forward to today, and almost 1.8 million Americans have contracted COVID-19, 104,000 have died, and some areas of the country that have started to reopen are locking down again.
The implications are clear for PREIT, as the company disclosed in its quarterly filing with the Securities and Exchange Commission (SEC): "We are unable to conclude that it is probable that we will be able to meet our obligations arising within twelve months of the date of issuance of these financial statements and continue as a going concern."
The deal PREIT struck with its lenders in March now doesn't look like it goes nearly far enough to keep the company compliant with its debt covenants even during the renegotiated period.
What management is doing
The company does have some options, and management is taking steps to save shareholders and avoid being forced to go through bankruptcy. The first step is to continue working with lenders for additional relief. The reality is that the environment for retail has deteriorated far more than people expected back in March, and it could be in PREIT's lender's best interest to reach an agreement that allows it to remain a going concern and the owner and operator of the properties.
Banks can't be very excited about owning indoor malls right now. If there's any possible way to bridge the gap between the current environment and the eventual recovery, there's a chance lenders will extend PREIT a little more rope. Considering the debt in question is unsecured, this group of lenders falls behind other PREIT creditors in the capital structure. That alone could be enough incentive for a new deal. But it's far from guaranteed.
Additionally, the company does have other real estate assets it is working to monetize. In the quarterly release, PREIT disclosed the sale of assets that will result in about $133 million in improved net liquidity. But these are one-time benefits and will only serve in buying the company time to get through this crisis.
Can PREIT survive?
It boils down to how lenient lenders are willing and able to be. It looks like management has taken enough steps to cut costs and get enough liquidity on the books to ride out the worst of the downturn, but if PREIT can't stay compliant on the provisions of its unsecured credit facility, it won't matter. The way the debt is structured, once the company is out of compliance, it defaults and the entire amount -- $500 million -- will come due.
And if that happens, it will happen because the banks that funded the credit agreement won't play ball, and the company can't find anyone else willing to issue it credit under better terms to pay off that existing debt.
As things stand today, it's not looking very good for PREIT. With shares now trading for not much over $1, it's pretty clear where the market thinks this will go, and it's not likely to be a favorable outcome for investors. PREIT's death is not set in stone just yet, but as things stand today, it's not the best retail REIT to invest in for a turnaround.