Will sales clauses in leases soon become obsolete?
The retail landscape today looks different than it did just a few years ago. Brick-and-mortar retail is becoming more diverse. Brands are embracing different operational models and integrating more closely with online and mobile channels. Retailers like Bonobos, Warby Parker and Restoration Hardware are using physical locations purely as showrooms, a new trend that appears to be gaining significant traction.
The implications of these changes are varied and profound. For now, I want to focus on one particular issue. That issue centers on a single question: when a retailer reports sales numbers, what exactly are they reporting?
To put it another way, in a world where the clear lines between online and brick-and-mortar sales are blurring, how do we determine which channel gets the sales “credit” for any one transaction?
Jeff Green |
Consider these real-world examples from my own experiences. I recently ordered some Restoration Hardware bathmats through a brick-and-mortar location. I subsequently returned them for a different color, an exchange I conducted online. Is that a brick-and-mortar sale or an online sale? In a different scenario, I placed an online order with Bonobos, and ultimately wound up making an exchange at a brick-and-mortar Bonobos store where the item came from their warehouse. What kind of sale is that?
Those are just two examples in my own life – there are countless other permutations. Even if we determine which of those transactions is recorded as an online sale or a brick-and-mortar sale, it doesn’t begin to account for the true unknowns. For example, an online purchase prompted from a consumer walking past a storefront earlier in the day could be a questionable sale, or the opposite, someone using online or mobile tools to get a sense of what’s available and where the best price might be, then visiting a physical store to make a purchase.
It’s complicated, right?
The real question is why does any of this matter? It certainly provides some fodder for media writing dramatic headlines about the demise of brick-and-mortar and the ascendance of online and mobile sales. But does it matter to the retailer? Does Old Navy care whether the dollars on their bottom line got there through an online funnel or an over-the-counter transaction in a physical store?
On one level the answer is no, not really. A dollar is a dollar is a dollar. However, it does matter – potentially quite a lot – once we start thinking about the impact on leases and what gets reported to the landlord. Some rents are calculated based on sales, and many leases have sales-based provisions, incentives or kickout clauses that are triggered by a specific sales figure. While the retail landscape may be evolving rapidly, leases don’t change nearly that fast. Unless a lease has been signed fairly recently, it almost certainly doesn’t account for the online/inline nuances and gray areas that have emerged. Think about a retailer in the eight year of a 10-year lease. Consider how much has changed during that time. Ten years is a long time in the world of retail, and an even longer time in the world of online tools and mobile technology. To put it into perspective, the first iPhone had just been released a decade ago.
A new retail taxonomy
So what options do landlords have? How do they know that what they are getting from their tenants is an accurate reflection of brick-and-mortar sales? How do they address that “channel uncertainty” in their leases? Can they stop retailers from what amounts to creative reporting of sales to trigger opt-out clauses or to suppress rents? Auditing might be possible if both sides agree, but if it isn’t clear to the retailer how to categorize a sale, how can landlords be expected to monitor such a thing?
For sales-based leasing language to be meaningful and enforceable, the retailers and landlords would have to stipulate/agree to meticulous transaction tracking and categorization. Furthermore, to address the complexities and uncertainties I mentioned above, the industry would likely have to develop a kind of standardized “taxonomy” for all the different categories of retail transactions in a multichannel world.
I suspect what is more likely is the leasing language will change. Leases will, by necessity, become much more simplified. With sales figures becoming malleable to the point of being meaningless, sales clauses in leases will be somewhere between irrelevant and unenforceable, and will likely go away. We may see conditional clauses based on different metrics (co-tenancy specifications, for example), or we might just see the industry move toward a simpler leasing structure. Perhaps something more akin to a residential lease, where breaking the lease early incurs a financial penalty. Even now, some retailers are not required to report sales. So we certainly could be moving in that direction.
That’s all in the future, for leases that have yet to be written and negotiated. The difficulty right now is that landlords have no leverage, and retailers have no incentive to renegotiate existing leases. This is a challenging time for landlords trying to adjust to an evolving and increasingly multichannel industry.
Jeff Green, President and CEO of Jeff Green Partners, puts more than 30 years of real estate industry experience to work on behalf of retailers, property owners, developers and municipalities. He can be contacted at [email protected].