With the fallout from COVID-19, airports worldwide are faced with many unique—and never before contemplated—challenges. This pandemic has brought air traffic to a crawl, resulting in airports and their concessionaires being in a situation where existing rent structures and payments are no longer viable.
Since most commercial space leases do not factor in a complete breakdown of the commercial aviation system, how should airports and their retail concessionaires (e.g., food service, convenience, and specialty merchandise) deal with rent payments at a time of extreme uncertainty and little or no traffic? Just as airports are seeking relief and assistance from their national governments, so too are concessionaires seeking help in a situation that is not of their making.
While this article is centered around the recent FAA guidance for U.S. airports, these recommendations are broadly applicable to airports and their commercial concessionaires everywhere, subject to nuances of specific concession contracts or regulatory environments. The FAA guidance of March 28, 2020, allows for closure of concessions, although there may be impacts on the ability of an airport to meet its Airport Concession Disadvantaged Business Enterprise (ACDBE) goals, a focus in U.S. airports that is not applicable in the rest of the world.
Open for business?
Many concession locations will likely be temporarily shut down while there is little or no passenger traffic. However, simply closing all concessions is not a successful strategy for airports or concessionaires. While such closures do not violate grant assurances for U.S. airports, it would be better to come up with a way to keep businesses financially viable while maintaining some level of service, thereby ensuring concessions (and staff) are in place once traffic begins to recover.
According to the FAA, collection of rents may be put off (“Deferral of rental payments and/or fees, if adequately justified, is not likely to violate FAA’s grant assurances…”) but not waived (“…In general, there is no authority that would allow an airport to waive landing fees and terminal rents...”).
[Please note that industry organizations are working with the U.S. FAA to potentially modify their guidance. The situation is fluid, so all parties involved should refer to any updates of the FAA guidance before taking any action.]
The question that airport managers must ask themselves is which rent strategy is realistic in the current environment. Concessionaires are, in general, seeking some manner of rent relief from their airport partners. Airports are left with four basic responses: do nothing, suspend minimum annual guarantees (MAG), defer rent, or rent abatement. Let’s look at strengths and weaknesses of each response.
The first option is to do nothing and enforce existing contracts. This has been the option taken by some U.S. airports, which have even gone so far as to issue Notices of Default (likely for failure to maintain/operate required open hours). While this option will certainly keep the airport in line with FAA recommendations, this uncharitable approach will lead many concessionaires to consider abandoning airport contracts. With little or no concession sales, maintaining and collecting the contractual MAGs is just not practical.
The impact will be even greater on small business owners and ACDBEs with only one or two locations. Larger operators may have busier locations that can help support less-active locations for a short period. Single store operators do not have this luxury. If passenger traffic remains dramatically reduced, they will have no sales—and with no sales, or sales below a certain level, the concessions become no longer viable. Individual business owners will be forced to close permanently, and larger concessionaires will be more likely to consider walking away from their contracts with airports.
Enforcing concession contracts “as-is” is a virtual guarantee of business failure. Such failures, if enforced as breaches of contracts, will result in there being no concessions to serve passengers when they do eventually return. While the “do nothing” strategy might sound good to airports on paper, the probable result is that concessionaires will default, and locations will close.
Minimum Annual Guarantee (MAG) suspensions
One of the seemingly obvious means of aid would be to temporarily relieve concessionaires of the obligation to pay the contractual MAG. As MAGs are generally developed on past (or expected) performance, almost every current MAG will be obsolete as it was established based on a passenger flow level that is no longer achievable in the near term. Suspension of MAGs seems fair and reasonable, as concessionaires would then only be responsible for paying a percentage of their actual sales as rent.
However, this still presents a significant problem for concessionaires. While many of their variable costs can be minimized, fixed costs—such as other airport charges and insurance—cannot be changed. With stores remaining open, the incurred variable costs (e.g., personnel, utilities, percentage rent, etc.) will not be supported by the paltry passenger traffic.
Keeping fixed expenses largely unchanged while sales decrease will result in severe cuts to tenant profitability—or no profit at all. Again, this impact is felt more strongly by single store operators. Even if MAGs are suspended, store sales likely cannot support continued operations.
Another option, which appears to be acceptable to the FAA under the March 28 guidance, would be for an airport to postpone rent collection for several months. This would allow operators to conserve cash for operations during lean times, allowing concessionaires to repay the airports once there is a return to normality. Note that FAA rules require that this option, if chosen, would need to be offered to all airport tenants equally.
There are a few issues with this strategy. First, no one can determine with any certainty when “normal” will return. Is it three months, or twelve, or more? Second, it’s impossible to know what the new “normal” will be. What is certain is that passenger levels will take time to recover. Just as after other shocks to the system—such as September 11—traffic may take years to recover. That means that the deferred rents will need to be paid back (with interest) based on revenue from sales that may be lower than were originally projected.
In theory, this option would allow concessionaires to continue to operate until the COVID-19 pandemic ends. However, concessionaires may not be able to continue their businesses even though their operating expenses are temporarily reduced. Other expenses—particularly labor (and benefits and taxes)—may not be supportable, even if the business is not immediately required to pay rents to the airport. Each business has some calculable level of sales below which the vendor will lose money regardless of the rent deferral. Even if there is a way for the vendors to sustain current operations, expenses may well exceed their ability to repay back rents.
Rent abatement—not requiring vendors to pay any rent for a certain period—is the most extreme strategy available. The benefits of this option would be that it gives concessionaires the most potential to sustain some level of service while the pandemic continues and will put vendors in the best position to resume operations as passenger traffic increases. A combination of rent abatement and temporary closure of most concession units would help the airport to ensure that there is some level of concession services for passengers now. This option should also help to minimize or avoid concessionaire’s negative cash flow problems stemming from required future repayment of their rents.
The problems of this option are many. For one, this method clearly violates the FAA March 28 guidance as it would be a waiver of terminal rents (i.e., concessionaires would be given their space “for free” and the airport would receive nothing from whatever limited revenue that the operations produce). From the concessionaire’s point of view, even if there is no rent charged and no expectation of repayment, concession operations still may not be financially sustainable in the short term.
Without this non-aviation revenue, airports may also find they’re unable to sustain themselves. This problem becomes more acute as other airport tenants expect similar treatment under FAA guidelines. Unless the airport is shuttered, which can only be done with permission of the FAA, the airport will have bills to pay and no revenue with which to pay them. A failure to collect rents may also violate bond covenants on the financial offerings that have been previously used to finance airport construction. A default on bonds would have long-term consequences. At a minimum, a failure to make required bond payments would have a negative impact on bond ratings currently and in the future. This will limit the airport’s ability to improve its facilities when it eventually becomes necessary.
A combination of approaches
At the risk of stating the obvious, there is no easy solution to this situation. The options that will work best for the airport may not be permitted by the FAA. Likewise, concessionaires may not be able to support the solutions that work best for the airport.
A “one size fits all” solution may not be practical; airports are going to have to get creative. One such answer may be a combination of rent deferral, closure of select concession locations during the pandemic, and a change in other lease terms over the long term. Any of these ideas must be balanced against the airport’s commitments and its use and lease agreement as well as the financial condition of the concessionaire.
Generally, airports might consider providing a lease extension to give concessionaires a longer time to recoup their lost revenue. The lease extension can be predicated on the vendor meeting all other lease conditions and continuing to operate in a manner that maximizes revenue, such as providing outstanding customer service and ensuring that concession locations are well maintained. The delayed rent repayment should be made over an extended period—years, not months; should incur interest as allowed or required by law (e.g., Treasury note interest rates as per FAA’s March 28 guidance); and should not start until there has been a return to normality. Providing a level of flexibility as to when repayment begins must be included in any such extension.
In addition, MAGs should be reduced to levels that are more practical given current and expected future conditions. This may result in a separate MAG level during the pandemic, or them being eliminated completely until recovery begins. For airports that continue MAGs during the pandemic, they should consider utilizing a per-passenger MAG methodology. Percentage rents should also be reduced, at least during the pandemic. The airport should carefully consider the necessity of other charges that it levies and their reasonableness.
Mutually beneficial solution
All these recommended changes will require negotiation. Both parties must be willing to give a bit so that a mutually agreeable solution can be reached. No one is going to “win” these negotiations, but both sides must come together for mutual benefit—and the benefit of the traveling public.
Life in the immediate future will be different. Concessionaires may no longer earn profits at their pre-crisis level for some time, but their business operations still need to result in positive cash flows. Airports must continue to be self-sustaining, serving the public with facilities that provide outstanding customer experiences. The balance that allows for these imperatives needs to be recast for each individual airport in these new, uncertain times.