Dumping The Dead Weight
Jun 1, 2004 12:00 PM, Howard Makler
For as long as retailers have been opening stores they have been dealing with the unpleasant realities associated with excess space. Although a minority of retailers have profited from unneeded/unwanted real estate, most find it an exercise in mitigating liability and reducing loss. There is an oversupply of surplus retail real estate currently available, estimated at over 300 million square feet, with liabilities in the billions annually, and many reasons for it. New closings, an abundance of vacant space, overloaded in-house personnel, increased liabilities and decreased profits only aggravate the problem.
There are several reasons for having to dispose of excess space:
- A change in format
- Relocations
- Mergers and acquisitions
- Unprofitable, underperforming stores.
By closing an unprofitable store, an astute retailer can reduce losses and improve the bottom line. Perhaps 10 percent to 15 percent of the total number of stores might have to be closed. The CFO of a major retail chain recently told me that the company must sacrifice the profits of almost a dozen “very good” stores to offset the losses from one “very bad” store.
Having determined the problem, a chain must next decide who will spearhead the project — in-house experts or external specialists like Excess Space Retail Services.
In either case, the first step is evaluating leases for all relevant information, such as use restrictions, assignment/sublease language, including any necessary landlord approvals and any termination rights (e.g. co-tenancy, sales volume or other kickout provisions). Sometimes these clauses are not in obvious places and are easy to miss.
Whether you own or lease, you must accurately and honestly assess the value, or more probably the liability, associated with all real estate. It's often very difficult for a retailer to accept the fact that they paid $X two years ago and will then receive only 70 percent of $X for a sublease.
The next step is to realistically determine parameters for deal making, including establishing an asking and acceptable sale price on owned properties, and on leased properties setting both subleasing rents and buyout budgets. Rents and sale prices are influenced by market conditions, remaining length of term and desirability of space. How much a buyout will cost is dependent on additional variables, including the landlord's eagerness to cooperate and the availability of alternative tenants.
Landlord Duties
Most retailers prefer to mitigate their surplus real estate without becoming a landlord in the process. However, you should pursue negotiating a lease termination with your landlord while searching for an alternative user. From a strategic standpoint, the value and bargaining power of finding a replacement tenant is enormous. When an acceptable alternative user is in hand, you can use the rent that the new tenant will pay as a formula for establishing a lease termination fee. Alternatively, finding a prospective tenant that the landlord does not want (also referred to as a nuisance tenant) can be used purely as a bargaining chip to reduce buyout costs.
Many leases simply can't be terminated and must be subleased to mitigate damages. Some surplus locations are suitable for other retail uses while others need to ferret out creative or unorthodox users instead, generally generating less income.
Make certain you and your representatives use every conceivable method of communication to get the word out. There is no substitute for exposure.
Time is the worst enemy of retailers with surplus space. Once you have a plausible deal, even if it's not exactly within the parameters, it should be seriously considered. It almost always costs you more to wait!
EXCESS SPACE DISPOSITION
HOWARD MAKLER
Chairman of Excess Space Retail Services Inc., which specializes in real estate disposition and lease restructuring.
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