CREJ - Retail Properties Quarterly - February 2016
Consumer spending in Denver is at an all-time high. Consistent improvements to the economy have created positive momentum for retailers. The U.S. Department of Commerce recently reported that Colorado consumers are opening their wallets wider than ever before, according to personal consumption expenditures. Yet we still find shopping center owners struggling with vacancy. This is a far cry from the vacancy issues landlords experienced a few years ago, but the goal of every owner and broker is to put up the best sign in the business: 100 percent leased. Although the economic signs are trending in the right direction for retailers, we find growth is more careful and calculated in this post-recession economy. For landlords, this means that a one-size-fits-all approach to attracting tenants is not the best way to get your shopping center leased. Landlord Strategies Every shopping center owner needs to know what he wants to achieve out of his investment. Depending on the landlord’s plans, different incentives make sense. If he is looking to sell, it makes sense to give free rent and tenant improvements in exchange for higher lease rates. If he is a long-term holder, he should not take the risk on the upfront incentives; instead, he should go for steady, gradual increases over time. Some shopping center owners have good relationships with contractors and architects and may leverage those relationships to get deals and better pricing. Other landlords don’t want to take on that kind of work and the potential risk involved. Therefore, it is important to create a plan and strategy that fits the investor’s particular goals. Often we work with developers who want to sell a property once it reaches 90 percent occupancy. Their goal is to reach the highest rents possible, even if that means providing large TI dollars and other concessions. But some landlords do not have the capacity to provide substantial TI allowances. In these situations, we work with rent-abatement periods that equal the market TI. We will add the rent-abated period on to the lease term, giving the landlord a full five years of rent, which can create a nice long-term cash flow to the owner. A lot of new developments offer spaces that are left in a “cold grey shell,” meaning there is no heating, ventilating and air conditioning, drywall, plumbing or electrical. The idea is that these spaces can be customized to fit the tenant’s needs. National tenants typically fill these new spaces but, often, the last few spaces remain vacant for long periods of time. Smaller, local tenants are intimidated by the time and work involved to bring these spaces to a “vanilla shell” (HVAC, drywall, electrical), which would make the space ready for the tenant’s specific finishes. The time and expense to finish the grey-shell spaces can lead to smaller, local tenants hesitating to lease. Landlords also need to be willing to look at their property with a critical eye. Nobody likes to hear that their baby is ugly, but the first step to filling the last vacancies is to understand why they are vacant still. Parking, access, pricing and condition of the space are critical factors in assessing the desirability of a space. A broker with retail leasing competency can look at the space and give advice. It is important to accept the suggestions and understand that, at the end of the day, everyone’s goal should be getting to 100 percent leased. Key questions for landlords: • What is the length of property holding? • Do you have renovation plans? • Do you have connections to help with architecture and construction? • What types of tenants are the right fit for your vacant space? • Should unfinished grey-shell space be updated to the vanilla-box condition? • What are the drawbacks of your space – parking, pricing, condition of space, etc.? Incentives The most successful retail projects are made with the right tenant mix, which means finding tenants that complement each other’s businesses. The right mix helps overcome any project deficiencies. For example, if you have a few restaurants with big lunch business, you may find parking to be an issue during the midday hours. A tenant whose peak times are outside of those peak hours may be essential. If you have a shopping center that is not visible to a main road, you may find a tenant, like a unique restaurant, to be a draw for the other tenants. A location with access or visibility issues may benefit from tenants that are based on appointments (yoga, dentists and chiropractors), rather than impulse shopping. All tenants are not incentivized by the same things. Some tenants are worth risking up-front money and some are not. The deal structure should depend on the credit and financial ability of the tenant. It is important to understand the tenant’s operating history, experience and financials. This will help landlords creatively structure a deal that overcomes any tenant hesitation, while providing the economic outcome the landlord desires. Service tenants often are ideal for smaller neighborhood centers. These include financial and insurance companies, dry cleaners, hair and nail salons, restaurants, convenience stores and special medical service providers, such as dentists and chiropractors. These tenants can make the difference between 80 percent and 100 percent occupancy. Landlords must understand that although a national restaurant chain can pay $30 to $40 per square foot or higher in rents, it is not feasible for a lot of service tenants to stay afloat with these rents. Tenant Snapshots Restaurants can pay higher rents – they can pay around 8 percent of their sales – but have higher up-front infrastructure costs. They can create a larger parking burden, often have contingencies in liquor licenses and have a higher turnover ratio. Dentists can pay at the high-end range in rents and have a low default rate, but often require a large, upfront TI allowance and can need a lot of hand holding through the build-out process. National tenants like cell phone carriers, soft goods retailers and weight loss centers are considered national credit, which are attractive to investors. Typically they cannot pay the highest rents in the market and are not overly intensive on their parking use. They can be a much-needed addition to a tenant mix. Local daily needs tenants, such as nail salons, dry cleaners, liquor stores and hair salons, have a place in just about every neighborhood shopping center. They are not the national credit tenants that get investors excited to bid up investments, but these tenants are looking for a reasonable package in lease rates, TIs or free rent. Prospecting Local Tenants Often the best prospective tenants are right under your nose. Our first priority when prospecting for local service tenants is with the tenants who are already in business in the immediate surrounding area. The first thing we do is knock on the doors of the tenants in the immediate area, instead of trying to convince someone to open a second or third location across town. We try to identify which tenants may be paying more in adjacent shopping centers. We look to highlight an advantage of moving into our center, whether it is saving money or upgrading locations. It may be that our center went through recent upgrades that make it cleaner, brighter or more modern. They may be looking for financial incentives such as rent reductions, free rent or an opportunity to get more space for their expanding business. Or they may be looking for an opportunity to cut costs by getting a small, more efficient space than they are in now. It all comes down to walking in and talking to them, listening to what is important to their business, what their current situation may be lacking, and trying to create an opportunity for the tenant and the landlord. We find that we are most successful when we work to understand the goals and needs on both sides.