What they did was renegotiate the terms of their lease such that the retail tenant would pay a higher rent in exchange for cash payments from the owner. With the building showing a higher rent roll, it was able to command a higher value on the open market—eventually selling for a 91 percent premium over the cost of the original acquisition. And the buyer was made fully aware of the arrangement between tenant and landlord regarding the cash payments.
|650 Madison Avenue
Source: Google street view, Oct 2017
The article goes on to state that this practice is not limited to retail. This is something I know to be correct, having shopped for a rental apartment and seen the offers boasting “first month free.” In these lease agreements, the tenant is essentially agreeing to pay the same annual rent, but spaced over 11 larger payments instead of 12. It works well for transient tenants like students or young professionals that don’t typically sign for longer than a year, and allows the building owner to show a higher rent roll.
This all answers to some degree the question why retail rents might be a bit “sticky” and cause vacancy rates to rise, even as news of the retail apocalypse echoes overhead. Lowering retail rent represents a direct hit to the value of a much larger asset. Except the practice can perhaps buoy rents beyond what retailers are willing to pay. Today a growing number of larger retailers are realizing their rents are not pegged to anticipated sales. The following quote from the article sums it up:
It was in March of 2017 that Urban Outfitters’ CEO Richard Hayne first likened the retail environment to the housing bubble, apportioning much of the blame in store closures to eCommerce and the burden of real estate oversupply. Putzier and Maurier differ in that they see a stronger parallel between the inertia of untethered optimism in housing values, and what had been longstanding optimism in retail rents. But there are myriad ways the current retail moment and the housing bubble are different. The housing bubble burst because of the securitization of subprime mortgage debt, not because everybody discovered they could now buy their homes from Jeff Bezos. What I mean to say is we still consume housing in basically the same way as we did before the bubble. But contemporary retail consumptions feels to be a bit more avant garde with more showrooms, less inventory, rapid fulfillment, and everything in between.
Are we seeing a correction?
In Cushman and Wakefield’s most recent retail market report for Manhattan (Q1 2018), they identified three recent trends:
2. The SoHo sub-market recorded its eighth consecutive quarter with a drop in asking rents
3. Announcements of new pop-up store openings have slowed down, signaling the trend may be losing some of its steam.
Is this a correction? Are we seeing retail rents align with a more realistic market value? Is there a direct correlation between pop-up shop announcements and retail rents? Difficult to say. It does seem to say that property owners are becoming more inured to a condition they thought would be temporary. But an article from The Real Deal out today tells a different story, of rising rents in Brooklyn corridors where new development is taking place. Their narrative is one that says it’s mature (and more competitive) markets that have had to adjust their rents while retail pioneers seem to still be doing alright.
What does this mean for district managers?
It’s important to think strategically when approaching vacancies. If you observe a high rate in a district, you might now wonder if it stems from a lack of customer demand, or determine if there is simply a mismatch between asking rents, the tenants who can pay those rents, and if those specific tenants are in demand. Are local property owners institutional investors, or are they longstanding residents with no debt on their property? And of course, there may also simply be an issue with the individual operator, which is a whole other discussion. These are all good and necessary questions to ask oneself. Without asking them we cannot hope to arrive at good and necessary answers for addressing vacant spaces.
Thanks for reading!