Coming Together
Sep 1, 2009 12:00 PM, By Elaine Misonzhnik
Landlords and tenants have had a trying year, but it is time for the two sides to adopt a joint view of success.
For JMW Development LLC, the renegotiation request came rather unexpectedly. The Minneapolis-based real estate development firm had been working with discount retailer Target for several years on its Commerce Hill project in Woodbury, Minn. The chain was scheduled to open a 185,000-square-foot Super Target as the anchor for the 289,564-square-foot mixed-use center some time in 2010.
But at the beginning of July, out of the blue, Target informed JMW that it would not be able to inhabit the project unless it could rework the terms of its lease.
Some commentators have speculated the move could have been due to Target's lackluster performance in recent months. In June, Target's net sales fell 2.6 percent, to approximately $5.7 billion, compared to a year ago. Its same-store sales fell 6.2 percent, a bigger decline than the 5.1 percent reported for U.S. chain stores as a whole. Nevertheless, Target expects to open at least five stores in 2010 and might add 25 to that list going forward.
JMW declined to comment for Retail Traffic, but the company appeared taken aback by the turn of events, according to a report in the St. Paul Business Journal that said as recently as June the process appeared to be moving forward smoothly. Meanwhile, a spokesperson for Target said the retailer “remains interested in a location in Woodbury and we'll continue to work with the developer to find a solution.”
The situation is indicative of a problem currently plaguing the retail real estate industry. Both landlords and tenants are suffering in their own ways. Landlords are wrestling with higher vacancies, falling property valuations and debt loads that are impossible to pay off or refinance in the current credit climate. Retailers have seen sales volumes tank while credit remains limited and their peers continue to disappear. They are holding off on openings, closing stores, entering bankruptcy protection or, in worst case scenarios, liquidating entirely.
Navigating this difficult economic landscape has put retailers and landlords at loggerheads. The retailers are seeking rent concessions whether they need them or not. The landlords, desperate to maintain as much cash flow as possible and facing onerous loan covenants, are loath to grant them. Each side is suspicious of the other. And examples like the one taking place in Woodbury — where a retailer requests changes on a deal before the store has even opened — are not helping matters. Ultimately, however, an adversarial relationship hurts both sides. Retailers and landlords need each other to survive. That means they have to find a way to handle concession requests more amicably, while at the same time working together in areas like marketing and advertising to benefit both the center and the tenant. With everyone short on cash, this will not be easy. But as more and more tenants face the risk of bankruptcy and as an increasing number of malls and shopping centers face foreclosure, cooperation will be the main route to survival.
Balance of power
Despite both sides facing challenges, it's difficult to dispute the notion that retailers have gained the upper hand in lease negotiations. As the list of potential tenants shortens and vacancies rise, landlords have had to get used to a new world order, says Patrick C. Maxcy, partner in the corporate reorganization and bankruptcy practice of the law firm Sonnenschein Nath & Rosenthal LLP.
In the second quarter, the national vacancy rate for neighborhood and community shopping centers reached 10.0 percent, the highest level on record since 1992, according to Reis Inc., a New York City-based research firm. The vacancy rate for regional malls moved to 8.4 percent, the highest level since Reis started tracking regional mall statistics in 2000. Meanwhile, the number of stores U.S. retailers plan to open over the next two years has declined to 64,926 from 68,854 in January, according to research from RBC Capital Markets and Retail Lease Trac. Most of those still planning on expansion, including Quiznos, GameStop and Anytime Fitness, are small shop operators.
“It's a tenant's market out there and landlords are truly concerned, if not downright scared, about what happens if they lose one of their tenants,” Maxcy notes. “There was a time in the early 2000s when a lot of landlords couldn't wait to get the current tenants out and get someone else in.”
Back then, retail leasing was almost an order-filling business. Retailers enjoyed booming sales. In addition, retailers faced pressure from investors to expand. ICSC Dealmaking events were marked by rushed meetings between tenant reps and landlords. They flipped through leasing books and devoured vacant sites. That created a huge demand for new shopping center space — a demand developers were happy to oblige with construction of new projects or expansion of older ones. “The market has changed and it has changed drastically,” Maxcy says. “Home Depot isn't looking to rent space on every corner in America.”
Times are tough for the retailers, he adds. U.S. chain stores have not posted positive year-over-year same-store sales growth in nearly a year, according to ICSC. In June, the Total U.S. Traffic Index, which measures the number of people visiting both individual stores and enclosed malls, fell 12.2 percent compared to the same period last year, reports ShopperTrak, a Chicago-based retail intelligence firm.
The bleak outlook for sales growth over the next few years has put pressure on retailers to cut operating expenses wherever they can. Most have postponed new store openings. Some have had to close underperforming stores. Many have started asking for rent concessions on existing leases, whether in the form of outright rent reductions, freezes on scheduled rent increases, lower common area maintenance (CAM) charges or changes from base rents to rents based on percentage of sales.
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