Tesla and its Commercial Real Estate Missteps
Tesla and its Commercial Real Estate Missteps
What is the real estate community to make of Tesla, Inc., a company that frequently finds itself in the headlines, for better or worse? In early March Tesla announced preliminary plans to close some or all of its retail locations, potentially breaking many leases that will run into the next decade. By the company’s own account, Tesla reported $1.6 billion in total lease obligations for retail and non-retail uses. Commercial landlords appear to have quickly rebuked Tesla on this matter, but it is worth a closer look at what this means for Tesla and similar companies.
To be clear, Tesla is a groundbreaking company and is worthy of praise on many fronts. It has proven that there is a market for the electric car, and its initial marketing toward the affluent consumer appears well crafted in stoking demand among the broader population. Despite Tesla’s successes, it remains a high credit risk with weak operating margins and a highly leveraged balance sheet. These factors help inform us on management’s decision to seek ways to reduce operating expenses, including the announcement that it would work to shutter its retail locations.
Tesla is pressured by its high debt burden, inconsistent production capabilities, and high operating costs. Management needs to find ways to either trim expenses or raise revenues in order to effectively keep the lights on and the factories running. Its real estate is among the more costly components of its operations.
Within a few days of Tesla’s announcement to pare back its retail real estate footprint, management quickly walked back its plans and changed course, announcing price increases on its new vehicles. It appears likely the company realized, after the backlash, that raising revenue would be the easier problem to fix. For landlords, this offers some moderate respite. Tesla is likely to remain a high credit risk for years to come, but it still has a viable business.
Lessons Learned
What lessons can we take away from Tesla’s short-lived attempt at restructuring its balance sheet? The first is that under new accounting rules, companies must report operating leases on their balance sheets. This change makes many CFOs nervous, as it will shift off balance sheet leases onto the liabilities section of their balance sheet, effectively making the firm look weaker. That is not optically pleasing to investors or underwriters, but it does not materially change a company’s financial obligations by moving them onto the balance sheet. We may yet see more companies try to restructure their operating leases in the near term for just this reason. Owners should be vigilant against this trend.
Another takeaway here is that companies often have several levers they can pull when they become stressed. If a tenant approaches seeking relief or a reduction before the end of a lease term, it behooves landlords to engage the tenant and understand the issues. Landlords may find in many situations they can push back on tenant requests after gaining a clearer understanding of the company’s financial and market position.
Reach out to us at TRA to leverage our expertise in engaging and negotiating with distressed tenants or to find out how else we can support your asset management and acquisition teams.
