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Shopping Centers Struggle to Change Lease Structure

It could be several more months, if not years, before the shopping center industry fully rebounds from the consequences wrought by the virus and lockdowns, including a crushing number of U.S. retail bankruptcies, which in mid-November hit an 11-year high, and a significant rise in retail property loan delinquencies.

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Behind the scenes, the struggles are sure to accelerate lease structure changes that landlords were starting to implement prior to the pandemic. Landlords are looking more closely at a potential tenant’s value proposition, shortening terms compared with past practices, and tying  extension options to sales or footfall performance, says David Greensfelder, founder and managing principal of Greensfelder Real Estate Strategy, a provider of strategic planning, market analytics and development services for owners, occupiers and communities nationally.

“As few as five years ago, a 20-year triple-net-lease with a national credit tenant was gold, and landlords were delighted to grant options that would go out many years,” he says. “That has completely changed – in many cases, that lease is now seen as a liability, because we have no idea whether a tenant is going to be relevant in five years from now, much less 20. And if you have an irrelevant tenant, it’s bringing your entire project down.”

On top of that, shopping center leases could soon require tenants to maintain a robust and positive presence on Yelp, Google Maps and similar review platforms, Greensfelder adds. These and other sites have become hi-tech beacons that pull traffic to projects, much like elaborate highway signage and other visual signals of the past.  “I’ve seen LOI’s (letters of intent to lease) beginning to bring this up,” he says.

Some of the most dramatic lease changes could occur in percentage rent provisions, which provide landlords with rent revenue based on a tenant’s sales. Most existing leases today pre-date COVID-19 and the surge in BOPIS (buy-online, pick-up-in-store) due to social distancing.

But landlords have been grappling with how to account for online sales at physical retailers for years amid the percentage rent calculation’s limitations and potential for errors. Retailers may not include BOPIS transactions as sales, for example, but may count an item purchased online and returned to a store as a reduction in that store’s sales.  

Landlords are becoming more vigilant about receiving accurate sales numbers. That’s particularly important for the holiday season, when retailers book some 40 percent of their annual profit, according to Kenneth S. Lamy, founder and CEO of the Lamy Group, a financial management consultancy that helps landlords quantify retailer sales for rent collection.

Fourth quarter sales reports help retail property owners plan for the future as leases expire or, in this disruptive period, as tenants roll off lease modifications or ask for additional rent relief, he says. But Lamy adds that landlords need to take additional measures beyond simply relying on fourth quarter reports to assess and verify the true results.

“There’s a true lack of transparency in place, so there’s not a full understanding on the part of the landlord as to what’s really occurring,” Lamy says. “And you only get that transparency through auditing the store to capture the various buckets of revenue and activity that’s occurring. Without transparency, there’s no understanding, diagnosis or ability to develop a prescriptive action to take for a solution.”

While audits are certainly necessary to keep tenants honest, often landlords have to weigh the cost of conducting one with what the potential benefit, if any. Typically, for example, tenants don’t pay for an audit unless it uncovers a discrepancy that meets a certain threshold, Greensfelder says.

“I think we’re going to see a lot of thumb wrestling between landlords and tenants over how online sales and online returns get accounted for,” he says. “In terms of trends, the percentage rent clause is never going to look like it used to.”

Whether looking for a new or longstanding operator to fill space in your property, Retailsphere can help you identify and contact tenants that offer the most promise and long-term relevancy in today’s environment. Schedule a no-obligation demo today and see how easy Retailsphere can make your tenant search.

 

 

Tags: Store Closure, In Depth, Coronavirus

Written by Joe Gose