Five Items a Retailer Should Have in its Lease
With long-time anchors leaving malls, urgent care clinics moving into neighborhood centers, and online sellers applying pressure from all sides, retailers should take a new approach in structuring their lease agreements with property owners, say experts from both sides of the negotiations table.
“In today’s environment, it’s very interesting. Both retailers and landlords are under a lot of pressure, most of it coming from online competitors,” said Rick Burke, president of Lease Administration Solutions, an auditing firm for tenants. “It’s a scary situation for both sides.”
Anchors such as Sears and Macy’s leaving enclosed malls set in motion a range of scenarios that affect owners and tenants. In-line retailers pay high square-footage rates and shoulder all the common area costs in order to be next to those anchors. If one of them leaves, that high-rent traffic is bound to fall off.
But anchor churn could also be good for them. Say an owner replaces an anchor with three mid-box stores paying full rent and contributing to common area maintenance costs. CAM costs would then decrease for all in-line tenants, and perhaps square-footage rate for new tenants, too. And should traffic fall off, new lessees could negotiate percentage-of-sales rents based on the traffic-building merits of the anchor replacements.
Owners are all too aware of these contingencies, and the good ones are having little trouble dealing with them, according to Ami Ziff, director of national retail at Time Equities Inc.
“We bought a mall with a Sports Authority from GGP and GGP had a new anchor store ready to take the space in case Sports Authority didn’t emerge from bankruptcy — which it, of course, didn’t,” he said. “There was just a few months’ downtime. Also, a lot of these anchor leases are very old, and the property often sees a 200% to 400% rent increase with a new tenant.”
Dick Spinell, a partner in Mid-America Asset Management Inc., reports that the worst is over in the Midwestern region, and that rents are trending upward. “The stuff hit the fan back in 2007. We had 300 mid-box vacancies. But rental rates in 2016 are close to where we were at the peak,” he said.
That said, brick-and-mortar retailers find themselves rethinking their retail footprints. Here are five areas of concern that wise retail leasing managers will be paying extra special attention to in lease negotiations.
1. Co-tenancy clauses
When the anchor you’ve paid dearly to be in the path of leaves, you need to have a clause in your lease that ensures you’re paying the right rent for what you are getting with a new anchor or anchors.
When Paul Kinney was the leasing manager for Friendly’s Restaurants some years ago, the chain had a store in a mall that lost a department store and replaced it with a Dick’s Sporting Goods. Friendly’s depended on a steady stream of female shoppers with longer dwell times than men, but Dick’s customers skewed male. To make matters worse, the mall closed an entrance in the reconfiguration and the restaurant’s sales dropped by 15%.
“There’s more to think about in co-tenancy clauses than replacement time for the lost anchor. In our case, the question ended up being, ‘Will the new anchor bring in the right people?’” said Kinney, now the executive director of the National Retail Tenants Association. “If I’m going into a lease like that today, I’m going to use stronger language. I’d ask for a consideration if my sales dropped 30% or more. It was normal to give owners a year to replace an anchor. Nowadays, I would not give them a year.”
Tenants can also ask for a percentage rent clause, in which their rent reverts to a percentage of sales should a change in the mall mix adversely affect traffic. Kick-out clauses that allow retailers to back out of their leases under such conditions should also be explored.
“This keeps the landlord incented to keep the center as viable as possible. We’re seeing a lot of new co-tenancy clauses,” Burke said.
2. Shorter-term leases
This is a trend gaining favor among property owners as well as tenants. Look no further than the local neighborhood center, where new restaurant concepts and boutique fitness centers have replaced traditional retailers in an effort to build traffic. New formats trend quickly in these segments, and owners are starting to move to shorter lease terms to give them the ability to react to new needs in local marketplaces.
Retailers, too, need to allow themselves the nimbleness to react to changing customer mixes and many are re-considering the wisdom of signing 10- or 20-year leases. “Ten years is probably the average now, but we’re seeing more five-year terms and additions of a right of first refusal,” Burke said.
3. Permitted-use clauses
Retailers can pursue this route to make leasing arrangements more flexible and adapt their businesses to the changing nature of malls and shopping centers.
Most retail leases are explicit in the nature of the business and selection of merchandise lessees can sell within their four walls.
But retailers can seek to insert clauses allowing them to sell categories that once were the sole domain of a department store or big-box category killer. A gift shop at a mall with a Sears store, for instance, might fashion a lease that would allow it to sell small appliances should Sears depart.
4. Assignment clauses
Often the fail-safe for modern retail times, assignment clauses give tenants another escape route with the awarding of the right to sublet its space or re-assign its lease.
5. Occupancy costs and caps
The rise of mixed-use developments that blend office and residential space with retail raises plenty of questions about which tenants should be paying for what attendant costs.
“I deal with many mixed-use properties, and there’s always the question of how we’re going to work this out for the retailers,” said Nancy Erickson, executive managing director of retail services for Colliers International. “If they’re in ground-floor spaces in an office or residential tower, they don’t use the elevators, so why should they pay for them?”
This is a complicated issue to resolve, because office tenants commonly pay rent, which includes taxes, plus electric while retail tenants are on triple-net leases that break out taxes, insurance and CAM costs. Erickson said that, in the case of one New Jersey mixed-use complex she represented, elevator costs were eliminated from retailers’ leases, though they continued to be responsible for CAM costs.
“What a lot of retailers are attempting in mixed-use situations is to put a cap on their insurance, real estate tax and CAM costs,” Burke said.
More new configurations and new kinds of tenants are surely in retail’s near future. Online sellers are beginning to migrate into centers. Urgent care facilities and even hospital clinics are squeezing in between PetSmarts and Sam’s Clubs. It’s imperative that lease arrangements evolve with the landscape.
“Who knows what’s ultimately going to happen with Sears and Macy’s? There’s a lot of repositioning to be done,” Spinell said. “The strong are getting stronger, and the weak are getting weaker.”
Open-Air, Three Ways
Chris Ressa does not put a lot of stock in the word “experiential.” Though it’s become a companion to the word “retail” in the real estate industry, DLC Management Corp.’s senior VP of leasing finds it not up to the task of describing what’s too often missing at shopping venues.
“It’s too specific. It describes one thing, and not all that is really needed. I prefer the word ‘different,’ because that’s what brings people to your center,” Ressa posited. “Is there something available there — be it a trampoline park or a restaurant or a single item in a single store — that they cannot get anywhere else? That’s what building traffic is about.”
To his point: No matter if a center is open-air, enclosed, or a simple neighborhood strip center, product differentiation rules the day. Open-air centers come in many sizes and varieties, so Chain Store Age took a look at what’s new at three different properties run by three forward-thinking developers: Retail Properties of America Inc., Mid-America Asset Management, and DLC.
Last year, DLC did, indeed, sign Launch Trampoline Park to a lease at the Court at Deptford, looking for it to inject a shot of different into a fairly average power center in Deptford Township, N.J. Since purchasing the 361,000-sq.-ft. center in 2014, DLC put a full-bore renovation and remerchandising program into effect that not only reimagined what new types of formats and restaurants could build traffic, but also what traditional retail mix could increase sales. In 2015, a 60,000-sq.-ft. Burlington Coat Factory opened at the center and Party City relocated to a larger 17,000-sq.-ft. space next to Dress Barn. The Court at Deptford’s newest anchor, Hobby Lobby, opened its doors last year.
“DLC is always looking for opportunities with properties that we see as undervalued,” Ressa said. “Deptford is in the Philadelphia MSA [metropolitan statistical area]. It’s a really soaring trade area — very dense with high income — and the center has great access between two busy roads. It was a power center that was in transition.”
After allocating the 60,000 square feet to Burlington, DLC was left with an L-shaped box that Launch Trampoline fit into like a jigsaw puzzle piece. “We wanted them because of what they brought to the party,” Ressa said. “We came in and reconfigured the center in a way that made sense for the community today.”
Growing, upscale communities need their Party City’s and Hobby Lobby’s, but they also need their Ann Taylors and Sur La Tables. In Naperville, Ill., an ever-burgeoning western suburb of Chicago, RPAI used open-air retail development to, in effect, add a High Street annex to an already popular downtown.
Main Street Promenade is a 182,000-sq.-ft. mixed-use development that has melded with downtown Naperville and made a significant contribution to its roster of more than 100 national brand and boutique stores and 40-plus dining establishments. A population of 215,000 sporting $130,000 average household incomes within a five-mile radius supports such a retail collection. Main Street Promenade’s 103,000 sq. ft. of street-front retail sports the old-fashioned, hanging signs of J. Crew, Hugo’s Frog Bar & Fish House, Anthropologie, White House Black Market and the aforementioned Ann Taylor and Sur La Table.
“Naperville is a great submarket, one of a handful of suburban downtowns that actually work,” said the president of RPAI’s Eastern Division, Matthew Beverly, who as VP of investments guided its acquisition of Main Street Promenade. “It fits with our stated strategy. We don’t chase tenants or configuration. We look for the best real estate in the best submarkets.”
In terms of demographic and sociographic effects, Beverly sees two scenarios informing RPAI on just what defines a desirable submarket for the kind of retail center it provides. One is a busy and time-strapped society that is learning the advantages of live-work-play environments putting nearly all they need within easy reach. The other is dual-income households that have abandoned the traditional nuclear family dinner and TV hour and go out to eat on a regular basis, often following the evening meal with a little strolling and window shopping.
The latter is surely the dynamic that has most contributed to the long-term success of Geneva Commons, a 15-year-old Mid-America-run complex in Geneva, Ill., not far from Naperville. Unlike Main Street Promenade, which is fused to its downtown, the nearly half-million-sq.-ft. Geneva property sits a little west of downtown. And while it retains Geneva’s upscale retail flavor, it augments it with national brands such as Barnes & Noble, Crate & Barrel, H&M and Victoria’s Secret. It’s also made itself its own brand of civic center.
“I think people see it as an extension of downtown, but what draws them is convenience. You can park right in front of the store you want to go to,” said Cathy Charhut, Geneva Commons’ one and only asset manager. She helped open the property in 2002, was retained to run it when Mid-America Asset Management took over its operations in 2005, and has never left.
Geneva Town Center has long fulfilled the “be different” edict with the symbiotic retail relationship it has developed with its downtown. But in achieving that position, it’s also been a standout in the field of experiential retail.
For several years, Geneva Commons has sponsored a concert series that features local talent every Wednesday and Sunday in June. It’s become a traditional summer happening in the region, drawing thousands of people who set up lawn chairs and blankets for picnicking. At Christmas, the center does a tree lighting ceremony with horse-drawn carriage rides and pictures with Santa. Mid-America is now making improvements to common areas that will make possible a series of outdoor movie nights this coming summer.
It recently installed a 20-ft.-by-14-ft. high-definition screen that will show movies, but also serve as an advertising vehicle for the center and its tenants. Two smaller screens will be added on either side of the center’s bell tower to accommodate as many moviegoers as possible. Also coming to Geneva Commons this year is more comfortable seating, a fire feature, and two interactive art sculptures.
“We’re always trying to attract the high-end tenant with the newest and hippest item, and we were inspired by The Bean sculpture in Chicago’s Millennium Park,” said Charhut. “We don’t know what the sculptures will be yet, but we’ve sent out a call to artists for proposals.”
But different doesn’t have to be a hundred-thousand-dollars’ worth of interactive sculpture. It can be something as simple as the blow-dry bar that DLC will soon be adding at The Court at Deptford.
“It will be the only one in Deptford, and it will bring in the female shopper,” Ressa said. “We’re a consumer-based economy, and if we offer people something different, we’ll be successful. It’s why, in the age of online shopping, QVC is still very successful. I was watching the other night and bought a baseboard cleaner they were showing. Why? Because it was something unavailable anywhere else.”
It’s no surprise the trend of opening retail spaces in historic buildings is booming and shows no sign of slowing down anytime soon. With urban redevelopment picking up steam in many cities across the country and vibrant mixed-use urban communities increasingly becoming a familiar feature on civic landscapes, opportunities for repurposing, renovating and reimagining historic spaces for contemporary retail use are abundant and in high demand. They present an appealing option to retailers looking for great space in dynamic and growing markets.
For all of the advantages that come with space in a historic building, there are plenty of challenges, as well. From design and functionality to safety and technical issues to coding and regulatory limitations, a historic space may require a number of expensive and/or time-consuming steps and solutions that can lead to delays, have an aesthetic impact and potentially affect the utility of the space.
Understanding the scope and scale of some of these challenges — as well as the strategies and best practices retailers can use to accommodate or overcome the most common obstacles associated with occupying space in a historic building — is an important first step for any retail decision maker considering such a move.
One of the most common challenges a retailer is likely to face when selecting a location in a historic building is adapting and working within the design and operational limitations that may be in place.
Many retailers have developed their own criteria and brand standards for what their space is supposed to look like and how it is supposed to operate. Those standards may include everything from the way they stage their merchandise to the overall look and feel of the facility. This might sound like a minor issue, but it can present a significant challenge when a retailer’s standards and practices butt up against historic and potentially limiting rules and regulations.
If a brand or a business is used to doing things a certain way, it can be tough to accept that it simply isn’t possible to continue doing so in a new space. The open ductwork and exposed brick that are so popular in many stores today may simply not be possible in a historic building, both for reasons of historic preservation and the difficulty and expense of modifying existing infrastructure.
Costs and complexities
Space in older buildings often comes in non-standard shapes and unusual footprints. That alone can be an impediment for some retailers, and it may require comprehensive redesign or reimagining of how the store will function. It is common in many urban markets for available spaces to be multistory units, which can be a challenge for retailers used to stores and layouts that occupy a single level. They are also more likely to be longer, rather than wider, posing additional design and layout challenges.
The challenge of a multi-story space extends well beyond the basics of store layout and customer flow. Multiple levels add a whole other layer (both literally and figuratively) of complexity regarding HVAC and other infrastructure.
In general, the cost per square foot to do any renovations or tenant improvements tends to be more expensive in a historic property than in a traditional suburban box. These are complex buildings that may have hidden issues and almost always come with more requirements and specifications. Those historical complexities can become more significant when changing uses — adapting an old warehouse to a retail space, for example.
One common expense and design and development headache that occurs in such instances involves dividing a building up into smaller spaces or individual units. Such a step is considered to be a change in occupancy, and any dividers would need to be fully functional fire walls, for example.
Changes to the façade or the exterior of the building may face particularly restrictive regulatory hurdles and proposed changes may first have to make their way through a complex approval process. In the city of Detroit, for example, that step alone can take 60 days. In other scenarios dealing with state or federal approvals, 90 to 120 days is more typical.
One of the appeals of a historic space is the potential to take advantage of historic tax credits. While such a financial benefit is certainly welcome, a historic property designation and corresponding tax credits come with a very specific set of rules about what is and is not permissible when it comes to renovating the space.
A slight deviation from those guidelines would result in punitive damage in the form of a loss of those (sometimes valuable) tax credits. Unfortunately, miscommunication between landlord and prospective tenants is all too common, and retailers may not have all the information they need in terms of design restrictions. Consequently, a question that needs to be asked and answered early on in the process is: “Are there any design limitations relative to historic guidelines?”
Most established retailers have a formal process for identifying, evaluating and selecting potential spaces, but some of that procedural standardization can be less of a help and more of a hindrance when it comes to looking at historic buildings.
Retailers need to be thoughtful and flexible as they evaluate potential sites, and they would be wise to work with an experienced consultant or other real estate partners familiar with historic properties and the issues facing retailers.
Renovating and retrofitting historic spaces for a contemporary retailer is equal parts art and science. The result, when executed correctly, can be a retail space that is both an aesthetic and experiential triumph, a space with the potential to deliver outstanding ROI for the upfront cost it takes to reconfigure and renovate.
Bob Kraemeris a co-founder of the Detroit-based Kraemer Design Group.