How Can Landlords and Retailers Help Each Other?
(As printed in Northeast Real Estate Business)
Tenants and landlords both faced a tough reality in 2009: they’d be far better off replacing their traditionally adversarial relationship with a partnership to assure their mutual health, if not their survival. The name of the game now is filling space. Rather than sacrifice more of their valued tenants, landlords are realizing they have to get creative and offer various incentives, enticements and rent concessions that they wouldn’t have considered at the height of the market just a few years ago.
The deal-making options remain on the table in 2010. Here’s an overview of some of those strategies:
Because shopping center landlords typically have mortgages to pay based on a tenant rent flow, they’re not always in a position to grant steep rent reductions or out-and-out free rent. But what they can offer is free rent, in effect, that’s prorated over several years. This is a win-win for both parties because the retailer is getting the rent adjustment it needs and the landlord isn’t getting beat up from a financing or valuation standpoint.
We also see deals where gradual step-up in rent occurs. For example, if a landlord wants a long-term “market” rent of $20,000 per month, but the tenant can’t reconcile those numbers under present conditions, the landlord might agree to accept something like $12,000 the first year, $14,000 the next and so on until the tenant is paying the full amount, with standard increases set to kick in during ensuing years. This helps the landlords recoup the shortfall and gives tenants more leeway to build their businesses in tough times and eventually gives landlords the market rent they need.
Every deal is critical these days, particularly as shrinking retail occupancies cause “co-tenancy clauses” to kick in for some retailers. This can start a devastating domino effect where one vacancy leads to another. Once a center gets the reputation of being half-empty, it is a disappointment for the landlord, for the tenant and for the consumer.
It is much better to nip the problem in the bud by offering the would-be departing tenant an alternative of half their average rent for six months to a year, which allows them more latitude to re-evaluate their situation. Similarly, many tenants have a “go-dark clause” that allows them to close without reason before the end of their term, even though they’re still obligated to pay rent. In many of these cases, the tenant will agree to keep operating if their rent is reduced. But as with all partnerships, trust is earned—if tenants are seeking rent breaks, they should expect to open their books to show their pain to the landlord.
Landlords can also offer performance-based deals with tenants. For example, a tenant might agree to pay $22 per-square-foot over the first 5 years of a lease if they can generate $300 of sales per square foot, then pay $25 per square foot if they hit $400 per square foot in sales, and so on. Other deals can be structured so retailers pay a percentage-of-sales rent for three years, then permanently lock into the three-year average when they enter the fourth year of their lease.
We’ve seen some tenants agree to pre-pay their rent at a discount, which is a good solution if the landlord is hurting for cash flow. It also assures that the landlord won’t have to chase the tenant for rent at any point – another win-win.
As for aggressive tenant recruitment tactics, landlords can offer tenants the flexibility to cancel their leases during their term with minor termination penalties. Temporary pop-up stores are another good way for landlords to fill spaces and derive immediate income – and for tenants to test-market their products with minimal risks. Such leases can be structured for longer term options.
Robin Abrams is an X Team International partner and executive vice president of New York-based The Lansco Corporation.
Jerry Welkis is an X Team International partner and president of New York-based Welco Realty, Inc.
