Dog Day Retailing
Much is made of the sale of shopping centre assets by property funds. Every so often news breaks of shopping centres being “re-positioned” with the launching of next-generation retailers, and property portfolios being boosted by the growth of hubs into regional and super-regional centres.
But what of the smaller retailers who pump the sales required to maintain these balance sheets, what about the little guys ? News about retailers is often dominated by stories of business closures, predatory leasing practices and unrealistic demands from landlords at the top of the food chain.
This article takes a deliberately different view on the bargaining power of retailers facing two common scenarios, pioneering a new site or wrestling with a renewal. It hopes to arm them with the ability step back and recalibrate. To better control the outcome not by climbing Everest, but by understanding the importance of time.
Leases are not infinite.
All leases end. The end date is usually printed on the front page of the lease, and if not, it is only a matter of turning a few pages. Why then do so many retailers express shock and disappointment they are being forced to close-down or renegotiate at the end of the lease ? Did they not read the lease?
A tenant is given a draft lease usually months before they sign-off on the final deal. Draft leases, particularly in shopping centres follow a familiar, time-worn path. The landlord’s expectations regarding demolition and redevelopment, refurbishment and upgrade obligations, incentives and clawbacks, among others, are all spelled out in black and white.
A new tenant is always at an advantage.
A new tenant can decide whether the terms and conditions of the proposed lease are compatible with his or her interests. If the lease occupation cost is too high, the length of the lease too short, the permitted use too restrictive, the landlord contribution too low, then he or she has a distinct advantage, the advantage of choice.
A new tenant can always say no.
By contrast, a sitting tenant, is at a distinct disadvantage. Having either bought the business or pioneered the site, a sitting tenant has a lot more to lose by closing the business and vacating at the end of the lease. At risk is the entire capital invested by the tenant in the assets and goodwill of the business especially, as is the case in shopping centres, if the tenant cannot preserve the goodwill by relocating close-by.
Remember every sitting tenant was once a new tenant. The quality of their outcomes depends on how well they understand and manage time.
There are no surprises in retail property.
During the life of a lease, the rent will increase, consumer trends will change and landlords will seek to keep in front of the latest fashions.
Shopping centres are in the excitement business, they need to drive spending by offering shoppers something more than a place to shop. To compete with competition on-line, shopping centres must offer real-life experiences, that excite, attract and motivate shoppers. What was on trend 5 years ago is no longer. The need to stay relevant dictates there will be renovations, traffic patterns will be disturbed, food courts redeveloped and premises (and businesses) demolished. Hardly a surprise seeing each one of these outcomes is written, in plain English, into the majority of lease documents.
When is the best time to plant a tree ? Ten years ago. When is the next best time ? Now.
Retailers operating from leased premises are on the clock. They have agreed to vacate, de-fit and make good. That date is written in the lease much like the expiry date on a carton of milk. It is how a retailer prepares for that date that can improve the quality of outcome.
Here, the importance of exit-planning makes its entrance. Do retailers expect to ride the train for ever? Of course not, but how many have an exit plan that moderates the risks most commonly complained of ? You need not worry about rent increases, securing lease renewals, refurbishment or demolition clauses if you have sold your business.
Investment and business valuation principles are beyond the scope of this article save to say bricks-and-mortar retail businesses are commonly sold on an earnings multiple. Earnings (or profit) is an annual calculation and it is not uncommon for business agents or brokers to refer the price paid for a business in terms of “years of profit”.
A profitable business with a long lease attracts a higher price than the same business with only months left, which is basically unsellable.
The theory of time decay simplified, says the longer you hold on to your lease the less it (and your business) will be worth. By extension, the value of a retail business can be determined with reference to two items of data known to a new tenant before he or she signs the lease.
Knowledge is power.
Occupation cost, and length of lease. These are in plain view from the outset.
It does not take much to apply industry benchmarks to the occupation cost (rent, outgoings and levies) sought by a landlord. Benchmarks will give you a way to work up to annual sales and down to the bottom line profit. In shopping centres, industry benchmarks can be compared with the annual estimated turnover for specialty shops which the landlord is obliged to disclose for each specialty retail category.
If the occupation cost and length of lease do not allow you to break-even, trade profitably without interference and sell the business for full value, then new tenants can always exercise the advantage of choice and choose not to sign the lease.
Sitting tenants can arm themselves with two important pieces of data. First, the value of their business based on the current lease and current profitability. Second, the value of the business with a longer or perhaps more favourable lease. These pieces of information may allow a sitting tenant to decide whether to bank the profit and see out the lease, or to start a conversation with centre management about securing a longer term.
Sitting tenants should consider the benefit of a well-timed sale of business on favourable terms. Time decay is real. Landlords will always want more. By clarifying their ultimate goal retailers can avoid locking themselves into a positional power-play over the rent with their landlord.
By re-framing the conversation and aligning themselves with the landlord’s reality, sitting tenants have the opportunity to develop and explore alternatives by creating value for the landlord. Rather than confronting the natural instinct of landlords to amplify the rent, a sitting tenant may achieve a more valuable outcome by recasting its business case to compliment centre management strategies for growth and consumer engagement. These conversations take time. The best time to start ? Now.
Article by Peter Panagiotopoulos, leasing director, Craft Legal.