Owners and Tenants Wrestle Over Rent Reduction Requests (3/12)
Mar 12, 2009 12:20 PM, By Jennifer Popovec
About 700 shopping center owners and managers across the United States recently received form letters from a major big-box retail tenant. "Since times are tough, we've decided to unilaterally reduce our rent by 25 percent," the letter read. Enclosed in the envelopes were checks to the landlords for the newly decreased amounts. In all, that 25 percent slashing of rent translates into a $30,000 annual reduction per lease and total annual savings of $21 million for the retailer in question.
One owner who received the letter (who didn't want to be named in this story) wavered between disgust and admiration for the retailer's "chutzpah". He says he's never been in a position where a retailer simply asserted a rent reduction and assumed it would fly with no input at all from landlords.
"I can't accept the check and just move on," the owner says. "I can't allow my tenants to change the terms of their leases at will and set their own rent. If they need relief, they should come to me and ask for it. Then I can make a decision about whether they get it or not."
These are uncharted waters. Faced with arguably the deepest and longest recession since World War II and the worst financial crisis since the Great Depression, the tenant/landlord relationship is being tested in new ways. How both sides respond could go a long way in determining the health of the industry in years to come.
Both owners and retailers are hurting. Each side is trying to survive. On the surface, it looks like they have opposing objectives: one wants to preserve rent and the other wants to reduce rent. And both parties are suspicious of each other--owners fear retailers are trying to take advantage of them, while retailers feel owners simply are being unresponsive to their struggles. That may make it hard for landlords and tenants to be able to put themselves in each other's shoes and find a way to work together.
Yet many owners and retailers are slowly coming to realize they are not in contretemps, and in fact share the same goal--they both want the retailer to be successful and to continue to operate in the center. With this common ground, they're taking a collaborative approach in dealing with today's market and are working through rent relief requests as a team.
"I am seeing more of a partnership between landlords and their tenants," says Henry Pharr III, an attorney with Charlotte, N.C.-based Horack Talley who specializes in landlord/tenant litigation. "They are saying 'We're all getting hit hard so let's try to work together as best we can.' The games played during the go-go times… the egos and pride… that has all gone away."
To be sure, these troubles are coming after an extremely robust run for landlords, who enjoyed a long boom in the sector and capitalized with healthy rental gains for years. Over the 10-year period spanning 1999 thru 2008, effective rents rose 23.2 percent, according to Reis. Owners suffered negative rent growth only one year during that period--a decrease of 1.1 percent in 2008. Over the past five years alone, effective rents spiked 10.8 percent, Reis reports.
Today, that situation has reversed. Retail vacancies are rising, reaching levels not seen in a decade. At the end of 2008, the blended retail vacancy rate (which looks at regional malls and community and power centers) hit 8.3 percent, according to Reis Inc. (See chart.) At neighborhood and community shopping centers, the vacancy rate rose to 8.9 percent from 8.4 percent in the third quarter, the highest since Reis began publishing quarterly data in 1999. Regional mall vacancies rose to 7.1 percent last quarter from 6.6 percent in the third quarter. It was the highest vacancy rate since Reis began tracking regional malls in 2000.
Yet, it's impossible to ignore how much retailers are also suffering. Retail sales in January 2009 were down 11.0 percent year-over-year, according to the U.S. Census Bureau. To put that in perspective, during the last recession, retail sales didn't drop at all. In 2001 retail sales rose 3.5 percent and in 2002 they rose 2.8 percent.
Because of such dismal sales, retail tenants have seen their occupancy costs as a percentage of sales increase. In the 1990s, for example, occupancy costs were typically below 10 percent. Throughout this decade, they've escalated (as rental rates have increased), yet remained manageable at 10 percent to 12 percent. Today, it's not unheard of for a retailer's occupancy costs to exceed 15 percent or even 20 percent--an amount that makes most stores unprofitable, according to Mez Birdie, director of retail services at NAI Realvest in Maitland, Fla.
For many retailers, the situation is desperate. Industry experts are predicting between 10,000 to 20,000 store closings in 2009, and a number of retailers including Circuit City and Linens'n'Things have already filed for bankruptcy and handed the keys back to their landlords. (For a list of announced closings to date in 2009, go here.
Overall, that creates a difficult environment that landlords and tenants will have to negotiate in 2009 and beyond.
Necessary tenants
Today, owners are receiving rent relief requests from retailers of all shapes and sizes.
"Even in good times, some mom and pop retailers ask for help with their rent, but now it's even worse because we have smaller retailers and national retailers hitting up their landlords at the same time," says Scott Frank, a partner in Arnstein & Lehr LLP's West Palm Beach, Fla. office and a member of its real estate practice group.
Experts advise that landlords need to first evaluate their own situations before considering retailer requests, Pharr says. First, owners should think about how much they need that particular tenant in their center. Landlords have to consider, for example, if losing a tenant could put the center's cash flow in more jeopardy than accepting reduced rent. "In today's market, a little money is better than no money," Frank says.
Moreover, owners should consider a center's tenant mix and the position the tenant fills. They need to have a clear understanding of the options if a tenant defaults or terminates a lease, experts suggest. For example, losing particular tenants could trip co-tenancy clauses, potentially causing more harm to a center's occupancy and cash flow. Of equal concern, if a retailer closes shop, how quickly will the owner be able to lease the space and at what rate?
"When the market was stronger, owners had no problems evicting their tenants because they had tenants waiting in the wings to take the space," Pharr says. "No one is waiting in the wings today."
Pharr recently helped an owner negotiate a recent reduction package with one of its restaurant tenants. The owner was willing to work with the tenant because the restaurant anchored the small strip center and because the space adjacent to the restaurant was already vacant. The modified lease allows the restaurant to pay a rent equal to 10 percent of sales for six months, and the difference between that amount and the original rental rate would be amortized over the life of the lease.
"Overall, the decision wasn't that hard to make because the owner said: 'I'd like to have this tenant because it attracts people, and that's good for my center,'" Pharr says.
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