How Retailers Can Own Their Real Estate Futures
James Alt, Marc Passalacqua
Despite industrywide anxiety, brick-and-mortar retail is not dying. But traditional retailers that have yet to evolve their approach to managing physical locations aren’t off the hook.
As consumer shopping habits change, e-commerce competitors find their brick-and-mortar footing and the mall’s heyday reaches an inflection point, retailers must be more strategic when planning and negotiating with landlords.
A Retail Apocalypse? More Like a Metamorphosis
For the last few years, cries of “retail is dying” have echoed across media headlines and industry analysts’ projections. The validity of these doomsday forecasts is up for debate.
Without question, certain indicators paint a bleak picture for the future of retail. By late 2017, more than 20 national retailers (a who’s who list of apparel, electronics and consumer goods brands) had filed for bankruptcy.
The U.S. in particular suffers from a glut of retail space, with 23.5 square feet per person — 43 percent more than Canada (16.4 square feet) and over twice as much as Australia (11.1 square feet). Confronted with excess supply, myriad major chains have been forced to eliminate stores. 4,000 U.S. stores shuttered in 2016, a number that surpassed 8,000 in 2017, and could creep to 13,000 in 2018. As stores close, the outlook for the malls that house them is similarly grim: Credit Suisse estimates that a quarter of U.S. malls will close by 2022.
Such ominous statistics don’t tell the full story. Across the industry, there are signs of life.
For starters, e-commerce still comprises only a fraction of consumer shopping. Online shopping accounted for 9.1 percent of all U.S. retail sales in Q3 2017, according to Census Bureau data. And despite the continuous wave of store closures, the overall retail vacancy rate held at around 10 percent from Q2 to Q3.
The biggest vote of confidence in favor of brick-and-mortar, ironically, comes from the e-commerce realm. As traditional retailers shrink their physical footprints and brace for (or attempt to ward off) major restructuring, a class of digital-first brands is making significant investments in square feet.
Brick-and-mortar isn’t on the verge of extinction. But in this fluctuating climate, retailers do have a responsibility to proactively negotiate leases and renewals to regain, or maintain, stability.
Mapping the Mall's Trajectory
The rise and stall of the U.S. shopping mall offers a telling microcosm of changes unfolding across the retail industry.
After decades of growth, mall owners and operators are finally coming to terms with oversaturation. There are just over 1,200 domestic malls today, up a mere 4 percent from 2007. Between 2010 and 2017, two superregional malls were built, compared to 37 between 2002 and 2009. Due in part to shifting local economies, evolving shopper habits and the loss of anchor tenants, Class C and D malls face the most turbulent future. More than 334 Class C and D malls are rated “high risk,” according to Green Street Advisors; almost a quarter of all malls are at risk for losing an anchor store.
In the wake of these changes, mall owners are looking to diversify. Nationwide, retail square footage is being repurposed for a range of new tenants — from amusement centers and aquariums to corporate offices and concert venues — in hopes of luring consumers.
The decline of Class C and D malls, however, presents an opportunity for tenants. In these low-performing environments, retailers have more power to negotiate flexible lease terms, including shorter renewals (for instance, one-year contracts compared to typical five to 10-year agreements).
Pressure Builds as Online Retailers Go Omnichannel
An oversupply of mall space isn’t the only factor pushing retailers to think strategically about leases. As brick-and-mortar brands contemplate shrinking their physical footprints, they face palpable heat from e-commerce retailers embracing the “clicks-to-bricks” movement.
For many born-online brands investing in physical shops, the business case seems to go beyond showrooming:
- Amazon: When the world’s largest online retailer bets on brick-and-mortar, it’s hard to ignore. Amazon began opening bookstores in 2015 claiming it wanted to return to the brand’s literary roots (with the benefit of vast troves of consumer data).
- Duluth Trading Company: The Wisconsin-based workwear apparel brand began as a catalog business in 1989, eventually launching an online storefront. The retailer has taken a methodical approach to brick-and-mortar, opening 31 stores between 2010 and late 2017 (with plans to eventually have 100). Rather than shift dollars away from its online and catalog operations, Duluth’s stores tend to boost direct sales in markets where they have brick-and-mortar roots.
- Rent the Runway: Four years after making designer dresses accessible to anyone with an internet connection, Rent the Runway began its brick-and-mortar journey in 2013 — and it’s paying off. Whereas less than 3 percent of online visitors make a purchase, that jumps to 15 percent of physical store walk-ins and 78 percent of shoppers who make an appointment with a stylist.
- Warby Parker: The e-commerce eyeglass company, founded in 2010, opened its first physical store in 2013. The retailer opened more than 20 new locations in 2017, bringing its total footprint to nearly 70 shops. In an interview, co-CEO Dave Gilboa claimed that the company drives a nearly even split between in-store and online revenue. In his words, “We don’t think retail is dead. We think mediocre retail is dead.”
On one hand, this influx of e-commerce retailers opening brick-and-mortar locations proves that retail is alive and well. At the same time, digital brands’ demand for space could give landlords more power when negotiating terms with traditional retail tenants. It’s worth noting that this leverage has its limits, given that online retailers tend to set up shop in urban hubs and neighborhoods rather than malls.
Navigating Rent Negotiations: Five Considerations to Keep in Mind
Whether they’re on the precipice of financial distress or riding out a period of stability, all retailers can benefit from a more proactive approach to rent negotiations. Trouble spots across the sector ultimately give organizations room to bargain smarter. There are a few factors retail leaders must be mindful of when finalizing leases:
- Don’t be too quick to sign long-term leases. Even chains that are financially healthy today can’t necessarily predict what will happen 12 or 18 months out. With the amount of high-yield retail borrowings slated to mature in 2018 totaling $1.9 billion, retailers need to prepare for a range of potential future states. Shorter leases can be a boon to mall landlords as well, since multiyear agreements make it difficult to achieve the diversity needed to stay afloat.
- Push for new payment structures. It’s in retailers’ best interests to work with landlords on percentage-of-sales rent payments, rather than fixed amounts. To a degree, transitioning rent into a variable expense shields everyone from industry volatility: It creates flexibility for retailers, while ensuring landlords continue to get paid month-to-month.
- Know what concessions you’re willing (and able) to make. Before kicking off rent discussions, retail leaders need a complete understanding of what can (or can’t) be compromised. For instance, termination options and minimum rent payments are a sliding scale; retailers should have an accurate read on where they can fall without negatively impacting operations.
- Understand your global footprint. When contemplating new store locations, think about the big picture, not case-by-case scenarios. Instead of targeting individual malls, assess an entire trade area or market. Look at the opening year and returns of stores you already operate to assess whether you can maintain those numbers as your fleet expands. As the future of malls remains questionable, it’s also essential to know the economics of different store formats (e.g., mall, strip, street or outlet) for your business.
- Negotiate across locations. Retailers with multiple stores under the same landlord have room to get creative. Consider, for example, accepting modest rent increases in profitable locations in order to get major concessions in struggling stores. Scenarios like these may give retailers bargaining power to lower the rent on the failing location, or agree to terminate the lease early.
During a time when many cards appear to be stacked against the traditional retailer, a glimmer of optimism lies in real estate. Amid rapid changes and a dose of chaos, a tenant friendly environment emerged. Now it’s up to retailers to take full advantage of it.Download Now