A few months ago, it seemed like the retail industry was experiencing a metaphoric Tsunami. We were pummeled with daily headlines: “Retail Sales Plummet in December,” “Retail Facing Tough Times,” “Credit Crunch Hits Landlords Hard,” and on it went ad nauseam. The cacophony of the daily dirge was so deafening that the public became jaded to an extent. Of course, the timing could not have been more inopportune: it was at the height of the holiday shopping season. In Connecticut, Linens ‘n Things had just closed its last store, and Circuit City was on its last leg heading towards bankruptcy.
It all seems like such a distant memory, but has very much changed in a few months? Notwithstanding the behemoth that was the General Growth bankruptcy filing in April 2009, it is safe to say that compared to the auto industry, the retail industry is off life support — for now. The next few months will determine whether it will continue to breathe on its own on a long term basis.
RETAIL’S TRIPARTITE TERRAIN
The retail shopping center industry is not a monolith; it is composed of a heterogeneous mix. Although there are exceptions to each rule (the more recent “lifestyle center” phenomenon comes to mind), retail shopping centers generally can be categorized into three major types: the enclosed regional malls; the unenclosed power centers or big box centers; and the neighborhood strip shopping centers. Each is known for a particular tenant mix. For example, the regional malls are usually anchored by national department stores such as Macy’s, Nordstrom, J.C. Penney, Sears, etc. In Connecticut, these include the Westfieldowned malls in Meriden, Millford and Trumbull; the Taubman-owned Westfarms Mall in Farmington, and the Simon-owned Crystal Mall in Waterford. The power centers or big boxes on stand-alone pads are generally leased by tenants such as Best Buy, Walmart, Bed Bath & Beyond, Kohl’s, Lowe’s, Home Depot, etc. Neighborhood strip shopping centers have a bit more ubiquitous presence in the retail landscape in that they are generally anchored by grocery or drug chains such as Stop & Shop, A&P, CVS, Walgreens, Rite Aid, etc. Additionally, strip centers are more likely to house tenants such as the typical take-out restaurants, pizza shops and other similar eateries, as well as optical shops or others offering tax preparation services. To be sure, some of these tenants do not fit neatly into these categories, but the exceptions in these cases do not dilute the general rule.
The distinction drawn among the regional malls, power centers and neighborhood strip malls is necessary in order to appreciate the fact that remarkably, not all retail tenants did as badly a few months ago, or are doing as badly today. Of the three centers, strip centers, precisely because of their tenant mix, seem to have suffered or are suffering less decline in sales than the other two types of centers for obvious reasons: they sell basic necessity items that we need (not necessarily want), so they have priority over the consumer’s non-discretionary income. If there is a choice between buying groceries or purchasing apparel, jewelry, or home accessories, is it a small wonder where the consumer’s dollars will go? So while landlords and developers of regional malls and power centers may be struggling to retain tenants, the traffic flow in strip centers remains robust. Traffic flow into a shopping center is landlord’s gold, but how the tenant capitalizes on the traffic is by in large left up to the tenant’s creativity.
THE SYMBIOTIC RELATIONSHIP
Because there are still distressed landlords and tenants out there, both entities need to explore ways to achieve a common ground. For every recalcitrant landlord out there, there are two or three who are willing to make a deal with a tenant in trouble. Desperate times will require unconventional solutions. A diverse tenant mix — both in size and use — is equally as beneficial to the larger anchor tenant as it is to the landlord. The demise of one small Mom & Pop store in a Mall may hardly cause a ripple initially, but if a few of these less-than-large tenants continue to go dark, the domino effect would be both palpable and detrimental to the anchor tenant and the landlord alike. The landlord does not want such a scenario because in some situations, the remaining tenants may have what are called “CoTenancy” provisions in their leases which could, in most instances, allow the tenant the right to seek a reduction in rent based on a reduction in total tenant occupancy in the center, or in some cases due to the closing of a marquee store. On the other hand, notwithstanding the short-term rental windfall, the remaining tenants would much prefer a fully occupied, vibrant Center rather than one that is mostly dark due to vacancies.
A few months back, one of my developer clients stressed to me that landlords are seeking to build long-term relationships with their tenants: “It is about building partnerships.” This philosophy is no less important today; it continues to be a symbiotic relationship – each relies on the other to some extent for survivability. To that end, landlords generally prefer that tenants take a more proactive approach in managing their bottom line. Troubled tenants need to approach landlords earlier in the process, rather than later regarding ways to ameliorate the tenant’s economic situation. Although “Rent Abatement” seems to be the term de jour these days, the term is hardly novel; it has been a familiar concept in the industry for a very long time: it essentially requires the landlord to agree to re-negotiate the rental terms of the lease – on a temporary or permanent basis – to benefit the tenant’s cash flow. For most landlords, there is no fast and easy rule; each tenant request is considered on a case-by-case basis. One universal guideline applied is an analysis of the tenant’s comparitive sales figures to determine the tenant’s eligibility. However, a landlord will not offer a tenant rent abatement no matter how horrible the tenant’s sales figures are, if the tenant’s long-term survival in the center is hopeless. A landlord will not throw good money after bad just to be benevolent.
Once a request for abatement is made, the tenant should expect the landlord to ask for some concessions. These might include the unilateral right to recapture the space; or amending the lease to eliminate tenant-friendly provisions such as co-tenancy clauses, restrictive covenants or exclusives. For some tenants with sufficient leverage, the request for tenant abatement will not necessarily redound to the total elimination of tenant-friendly clauses, so the landlord will need to seek less radical concessions. Nonetheless, for some landlords that have been negatively impacted, co-tenancy clauses will either become a relic in future leases, or will necessarily undergo rigorous scrutiny during lease negotiations.
To the extent that municipalities are also affected by retail vacancies in the form of lower tax revenues, it would seem to make good business sense for the building and zoning officials in the Cities and Towns to exercise a bit more flexibility in streamlining the oftentimes brutal permitting process to make it less onerous for landlords who need to expeditiously mitigate their damages by locating replacement tenants for the abandoned or vacant spaces.
ANTI-DARWINISM: NEGOTIATE TO SURVIVE
Ironically, the current retail terrain is one where the survival of the fittest might yield a lose/lose proposition. Granted, the terrain is not as bleak as a few months back, but it is still precarious nonetheless. For many retail landlords and tenants, negotiating well-considered and less strident solutions can effectively bridge the gap between these credit-strapped times and economic recovery.