Four leasing strategies landlords should consider to diversify their tenant rosters.
Facing competition on all sides, shopping center owners seek new and creative retail concepts to differentiate their centers. The catch is that these intriguing, upstart retailers often have empty wallets. While stodgy-but-stable retailers emit no buzz (shoppers have already seen them on every corner), brash new concepts can’t afford the rent and don’t have established credit. What’s an ambitious property owner to do?
This competitive pressure is real, not theoretical. Some landlords find they must reposition their properties to attract a different customer base. For example, consider an owner whose nearby competitors already feature a slew of strong brand name retailers, such as Nordstrom or Marshalls. The owner may feel forced to differentiate its center by emphasizing unique, local retailers not accessible anywhere else, or by creating a distinctive lifestyle or experiential center.
But, “tenant mix” isn’t an art school exercise. Landlord leasing reps have to meet rent targets set by asset managers, fund guidelines, investors and lenders. To be an ideal tenant, a prospect must not only brim with novelty and appeal, but be awash in cash and credit.
The hunt is on for new and exciting retail concepts that have already stabilized themselves with cash flow, or at least are financed by a steady outside funding source. But where is the next Lululemon? There are only a few of these concepts racing through the retail property market right now.
One alternative is to simply accept the established tenant. It’s not too hard for a landlord to stomach a stale retailer that pays a high rent and maintains solid credit, and some higher profile centers have enough leverage to incentivize these commonplace retailers to tweak their fixed concept to provide something unique.
When it comes to handling an impetuous young company with an equally unpredictable financial profile, landlords should consider the following leasing strategies:
Structure the Deal to Avoid Landlord Risk
Consider deal structures that make the landlord comfortable with the risk. For example, provide for early landlord termination rights if the tenant hasn’t hit certain sales targets by designated dates. Limit the landlord’s obligation for significant tenant improvement dollars and other large outlays, or at least provide the landlord with lease security for these specific items. Consider granting exclusive use rights that start restrictively to protect the tenant, but then loosen (or even disappear) as the term elapses and the business strengthens (or proves itself untenable).
“Pop-Up” Concept
As the landlord reduces the term and contributes less to the deal financially, the structure approaches that of a classic “pop-up” lease relationship. Not just for Halloween stores anymore, pop-up leases have become customary in all segments of the retail leasing environment to create visibility for a new concept and “buzz” for the center. A pop-up lease arrangement can also serve as an experimental proving ground for an untested retailer. Arrange for a limited term of just a few months or a flexible month-to-month program, and accept a flat gross rental that creates predictability for the fledgling tenant (but the landlord should do its homework to anticipate and avoid unexpected costs for itself by taking account of potential costs for utilities or special services).
Rental Rates
Take a gamble on accepting lower base rent in exchange for a generous percentage rental payment if the tenant hits certain targets. Also consider providing a generous free rental period up front, in exchange for obtaining the desired, higher face rental rate later in the term, or structure rental abatement as a loan that gets repaid later as the business matures. Combine this concept with early landlord termination rights.
Lease Security
Leasing reps must face basic lease security concepts: a guaranty signed by a third party, a substantial security deposit or a letter of credit. Getting comfortable with an intriguing tenant that lacks strong financial resources may mean using more creativity to see the tenant’s strengths. For example, a successful boutique apparel retailer recently opened its second store, on a prime shopping street on the Westside of Los Angeles, despite slim financial backing. Providing only a rather limited personal guaranty, the tenant sold the landlord by telling the story of its solid track record in store number one and a long-devoted customer base.
It’s a timeless ideal to seek a prospect who is both attractive and rich. But, when it comes to ideal tenants, if you can’t be with one you want, then use some creativity to value the one you’re with.
— Steven Heller is an attorney with Santa Monica, Calif.-based Gilchrist & Rutter PC, a real estate and business law firm, where he specializes in commercial leasing and also handles commercial real estate transactions. He can be reached at sheller@gilchristrutter.com.