COVER STORY, MAY 2010

STAYING OCCUPIED
Landlords work to retain retailers in concession-happy era.
By Jon Ross

The economic clouds have been shifting, and rays of sunshine may be around the corner, but in the retail world, financial outlooks are still slightly overcast. As with 2008 and 2009, retail real estate is primarily a tenants’ world; landlords have been forced to fulfill concession requests in order to keep retailers in place. Tenants — from big-box users to retailers looking for smaller amounts of space — realize the onus during the recession is on property owners. 

“In the past, when you had a lot of retailers competing for space, tenants knew that they probably couldn’t get everything on their wish list,” says Scott Shillings of Riverway Retail in Houston. “Now they feel like, ‘if the landlord really wants us, he’s going to do more.’”

This extra effort most often comes in the form of increased tenant improvements and free rent. Some users, however, have been asking for benefits like larger signage or a taller façade, but these requests are more rare. Pad users have also started demanding kick-out clauses that mature earlier in the lease than has been customarily offered. Jake Baker, managing principal of Riverway Retail, says tenants are demanding kick-outs after 2 years or 5 years in a 10-year lease. Historically, that clause would only be triggered after the 7th year.

Concessions are so prevalent because retailers feel owners should provide a little extra help as a cost of doing business in the current market. From an owner’s perspective, reasonable demands are easier to swallow than an empty storefront in a large retail property, which might convince other tenants to leave as well. “Some retailers have literally sent a form letter out to every landlord that said, ‘We need a rent concession of “X” percent, or we’re going to have to close this store,’” Baker says. “It was almost a mindset that retailers felt like they were due something back from these landlords.”

Two years ago, concessions were even more prevalent than they are today. But while landlords in Texas are currently dealing with a number of concession-seeking tenants, owners in the Lone Star State are fairing much better than those throughout the rest of the country. Retail occupancy levels around the state have remained strong, meaning that landlords don’t exactly have to beg to retain tenants.

“You still have to work really hard to maintain your levels of occupancy and to maintain the average rental rates in Texas as you do throughout the rest of the country,” says John Bemis, director of leasing and development for Jones Lang LaSalle. “The good news is that the occupancy levels in Texas have remained strong, which means the landlord does not have to grant concessions in Texas that they may have to grant elsewhere in situations that are a little tougher.”

Concessions have also dwindled as the economic picture has improved, shifting the power back to landlords. “Nationally, while we did not see any significant increase in sales in 2009 — in fact, in some parts of the country, there were some further declines in sales — what we did see was an increase in profitability for retailers,” Bemis says, pointing out that tenants who increase profitability can no longer use monetary excuses to try to get free rent. “Landlords in the rest of the country have really geared back on the type of concessions they’re willing to make.”

Until the financial markets right themselves, however, tenants will be able to exploit the disconnect between owners and lenders. If an owners’ hands are tied due to his lender, the lender is having trouble making deals in part because of government oversight.

“A lot of landlords are so closely tied to their debt pressure,” Shillings says. “The retailers feel like they now have the advantage in the marketplace. They feel they can take advantage of some better locations, pay less rent, and what that equates back to is that particular developer has to go back and almost get his lender’s blessing.”

In this industry, bargaining power has shifted to the retailers, but it’s just a matter of time until landlords are back in the driver’s seat. “It’s a pendulum,” Shillings says. “For so long, the landlords had the advantage. Now the tenants have the advantage, and it’s going to be that way for a while.”

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