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‘No Easy Deals’: High hopes, lack of space can make retail deals difficult

Jason S. Baker is an X Team International partner and co-founder and principal of Houston-based Baker Katz.

By Jason S. Baker

One of the biggest storylines in retail over the past few months has been the legitimately good news that retailers are finally back in the hunt for space. The uptick in demand has been so noticeable, in fact, that many landlords now believe the era of painful concessions has passed, and that it is high time to start pushing for deal terms that have more in common with the go-go years of the housing boom than they do with the darkest days of the Great Recession. 

But as our industry prepares to convene in Las Vegas for RECon 2012, it may be relevant to point out an overlooked reality of today’s retail markets. Prior to the recession, if you went on a sunset drive through a major city like Houston, the silhouetted skyline would have been dominated by construction cranes — so much so that you might have thought you were in Dubai or Shanghai. But in Houston as in most other major metros today, the cranes and bulldozers continue to sit idle. Yes, the likes of neighborhood shopping centers are being built here and there, but in the face of rapid population growth, the impact of this kind of construction is minimal at best. For example, Houston’s population is growing at such a swift pace, it would need to add about 5 million square feet of new retail space every year just to maintain its current, per-capita ratio of retail square footage (admittedly a high one at about 50 ft. to 55 ft. per person).

Retailers are keen on expanding, in other words, but the options available to them are more limited than even they may appreciate. This is true, not just because of the lack of new space coming on the market, but also because of some lingering psychology. Among retailers, expectations continue to run sky high. Some have fresh memories of cutting unprecedented deals with desperate landlords and see no reason why this should not continue in perpetuity. Others have only recently started to expand again, but have heard a few too many anecdotes about huge TI allotments, cheap rental rates and other supposed perks of today’s “tenants’ market.” Just as tenants have a strong psychological incentive to believe that space is still available for a song, however, landlords are no less eager to believe precisely the opposite. Many of them, having been burned by the former imperative to keep space leased at all costs, are now responding to tenant requests for sweet deals with a clear message that this is 2012, not 2009 and there’s not a chance they will even entertain what they consider an outrageous request.

As is often the case in both business and in life, the actual reality often lies, not at the end of either of these extremes, but somewhere in the middle. New construction would make finding this middle ground infinitely easier, of course, but that much-needed construction is not happening yet. And this is why deals today can seem harder to do than at any other time in recent memory, including the nadir of the recession itself!

Consider one of the strongest retail segments: food. For quick-serve restaurants and other such tenants (with their notoriously difficult parking requirements), the actual amount of space available seems to be shrinking. Occupancy is already high in the major metros. Without new construction the food sector “space race” will, at some point, come to a halt. You cannot expand if there is no space to expand into. For many of today’s growing chains, moreover, those mostly vacant shopping centers out in the far suburbs are simply not a viable pressure valve. Retailers will not always do the right thing necessarily, but today it is a sure bet that they will always do the safe thing. If a retailer did, say, 100 deals in ’04 or ’05, it might do 25 today. These highly scrutinized deals must be airtight given the high bar being set by today’s real estate committees. And for many chains, this means that new stores must be built in markets that offer high levels of density, income and education. Such neighborhoods tend to be in or near the urban core, which makes space in these markets that much harder to come by.

Can anything be done to help landlords and prospective tenants better understand each others’ positions and find that middle ground? Certainly, landlords as a rule have learned some valuable lessons as a result of the downturn. They tend to be more flexible, for example, with co-tenancy language, and so this represents one possible bridge. Mundane though it might sound, it can also be helpful to simply get the retailer in the car — to have the retail executive physically see and experience the overall atmosphere in the market itself. Someone who drove through that market seven years ago, when the bulldozers were running nonstop, will immediately notice the change: We all know that no construction means low supply and high demand, but “seeing is believing.” Communication, too, is critical. A robust dialog should help both the tenant and the landlord put some realistic limits on their mutual expectations.

All of this said, there is real reason for optimism. The energy and atmosphere at this year’s RECon are likely to be positive, and attendance will no doubt be stronger than it has been in more recent years. However, one fixture of RECons past will be in short supply — site plans with a true shot of becoming real-world, large-scale projects anytime in the near future. Deals are happening and will continue to happen, but those deals that do come to fruition will not come easily. They will take time, effort, patience and the willingness to make reasonable compromises.

Eventually, the business cycle will turn for the better. The banks will loosen their grip, the big anchors will get active again and the bulldozers and cranes — finally — will kick into action. Until then, it will be up to all of us to adapt. That should be second nature to many of us by now. After all, we’ve had a lot of practice.

Jason S. Baker is an X Team International partner and co-founder and principal of Houston-based Baker Katz, a full-service commercial real estate brokerage firm specializing in first-class retail tenant representation, project development and leasing.


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