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When It Comes To Retail Real Estate, Tenants Have a Distinct Upper Hand

When It Comes To Retail Real Estate, Tenants Have a Distinct Upper Hand

When It Comes To Retail Real Estate, Tenants Have a Distinct Upper Hand

Recent reports about retail real estate in Manhattan, and beyond, suggest that the outlook may be gloomier than once thought. Aside from cities such as Austin, which is attracting California residents, and Miami, where denizens of the Northeast have moved to wait out the Covid-19 pandemic in the sunshine, many urban areas with a significant retail presence are suffering, and experts agree that any improvement won’t be fast or easy.

That’s because retail was overstored, over-leveraged, and underperforming in many places before the coronavirus pandemic. Department stores lacked differentiation and had devolved into blandness, traffic in shopping centers slowed when malls those department store anchors closed, and luxury brands opened multiple locations in the same city, which often could support only one or two units, no less three or more. Of course, the rapid rise of e-commerce was also impacting physical retailers pre-pandemic, an effect that’s only accelerated over the last 10 months.

According to CoStar, a record 12,200 stores were announced for closure in 2020, which will account for 159 million square feet of gross leasable space, surpassing the record set in 2018. Traditional retailers such as JCPenney JCP+3.6%, Macy’s M-0.6%, Stein Mar SMRT+8.4%t, Bed Bath & Beyond BBBY-0.5% and Pier 1 Imports PIR 0.0% were responsible for some of the biggest closures, CoStar said.

Data from the Real Estate Board of New York found that all 17 Manhattan retail corridors in fall 2020 experienced a decrease in average asking rent since fall 2019, with declines ranging from 1% to 25%. REBNY called the asking rent drops “historic,” noting that eight corridors logged their lowest averages in at least a decade.

While asking rents fell significantly, rents at lease-signing were reported to be much lower, with some brokers citing average discrepancies between asking and taking rents of about 20%. Compounding the problem: the rise in retail availabilities, with 11 corridors seeing a jump in available space of 6% to 67%, which reflects a substantial slowdown in Manhattan since fall 2019.

“We have a slow road for recovery,” said Kazuko Morgan, vice chairman of Cushman & Wakefield CWK-5.1%. “There’s a lot of space available. This is true in most urban markets in the U.S. In big cities, mostly the downtown tourist corridors such as Manhattan’s SoHo and Fifth Avenue; Chicago’s Michigan Avenue; San Diego’s Third Street Promenade, Melrose Avenue in Los Angeles, and Kalakaua Avenue in Honolulu, tourism has come to a grinding halt. Those areas rely on office workers also – except Kalakaua Avenue – so they have a double whammy.”

Smaller tenants and digital native brands opening in neighborhood locations rather than prime shopping corridors, are less affected, Morgan said, adding, “They’re still expanding, but for the most part those are smaller-format stores, and therein lies the issue with these big commercial streets and districts – how do you replace the Gap GPS+0.5%, and other large retailers, which occupied big blocks of space.”

Morgan said retailers in these dire times can take solace in the reduction in asking rents. “They can look at this as an opportunity. How are we going to absorb all of that space. Landlords are being super-accommodating going forward, while this wasn’t the case before,” she said. “They have to be, if they want to get retail tenants for their spaces. Tenants have options. They have lots of options. Most urban markets also have minimum tenant allowances today.”

Debbie and Josh Goldberg, who own community centers in Westchester, Long Island, Putnam County and retail condos and small spaces in Manhattan’s Financial District, SoHo, TriBeCa, West Village, and Midtown, said their philosophy during the coronavirus pandemic has been to keep tenants at almost any cost. “If you push them out, you don’t know how long it’s going to take to find a new tenant,” Josh Goldberg said. “Installing new tenants is costly, between broker fees and tenant allowances. We thought, let’s help them as much as we can and we’ll renegotiate the lease over time.

“It’s very expensive to open a store,” Goldberg said. “It’s not just the rent. How many people are willing to open a new business regardless of what the rent is. This can only be described as a breakdown of the market. Large spaces will be shared or divided up with lower rents and much lower barrier to entry. Everyone is unhappy, but everyone is facing this reality.”

The Goldbergs took an offensive posture in the early months of the Covid-19 pandemic, reaching out to tenants and offering them forbearance almost immediately. “It’s a a harsh reality for property owners,” said Josh Goldberg. “You still have obligations to the banks, but it improved our relationships with tenants during a very stressful time and I think that’s worked in our favor. In spite of our willingness to forgive rent entirely, we lost some tenants because they couldn’t pay their operating costs. It’s sad.”

Some of the Goldbergs’ tenants asked for discounts while others sought to restructure leases based on percentage rent. “We’ve always been reluctant to do percentage rent deals with local tenants,” Goldberg said. “Now, we have a Guesst program that can plug directly into tenant’s POS. We can get daily reports on sales. The situation is forcing me to be more of a partner with my tenants.”

Andrea A. Abrams, international retail and brand advisor, founder of Abrams Global, and co-founder of Interconnected LLC, believes a turnaround will take years, not months. She said the situation became critical in the third quarter of 2020 when New York City residents stopped commuting to work and decided to move away from the city.

“The pool of available customers for many categories disappeared,” Abrams said. “Many retailers opened new stores in locales where their customers relocated. Many New York City retailers flocked to Florida following residential transplants. Others opened pop-ups in locations like the Hamptons.”

“What do we know about the way urban shoppers will shop when things get back to whatever will be the new normal. Retail in urban areas is so interdependent on a variety of factors,” said Stephen Stephanou, principal of Crown Retail Services. “Particularly for New York, with its reliance not only on office workers and residents, but also business travelers and tourists, even optimistically, it’s likely to take several years for things to stabilize. During the time of recovery, the city will need to address a number of infrastructure issues such as budget challenges for pubic transportation, policing, and other services, with reduced tax revenue.

“Taxi drivers are doing 91 percent less business,” Stephanou said. “It’s a symptom and result of how hard it is to be in business right now because there just aren’t enough people in Manhattan.”

Rick Friedland, a principal of Friedland Properties, which owns retail space on Madison Avenue, among other locations, sounded hopeful about the city’s prospects. “This is really just a function of looking forward rather than looking backwards,” he said. “As data comes out about 2020, obviously a lot of it is going to be pretty ugly. We’re digging out of that now, and for a host of reasons, 20021 looks a a lot brighter. Dealing with the last 10 months isn’t particularly pretty, but I don’t think that necessarily has a bearing on the next 10 months.”

While some landlords are trying to get approval from the city to change the types of users allowed in their properties, Friedland believes that may not be necessary. “I don’t know that uses are changing. Indoor food versus outdoor food is still food. Landlords and tenants are trying to be as creative as possible. There’s still intrinsic value to certain locations that would probably preclude a radical change in use.”

“Rents have come down,” said another Manhattan landlord, who asked for anonymity. “We’ve had leasing activity throughout 2020 and early this year. There are still tenants doing deals. If I were a well-capitalized tenant with a little foresight and vision, I’d sign a lease. You’re going to get 2020 Covid pricing, and a buildout allowance. By the time you’re ready to open, it will be the second half of 2021, life will have some semblance of normalcy, and you’ll have a 10-year lease priced at the bottom of the market.”

While retail corridors have been becoming less homogenous for the last decade with the Gap and H&M setting up shop on tony Fifth Avenue, the trend is continuing at a faster pace as landlords have fewer qualified retail tenants to choose from. Spanish fast-fashion chain Mango recently subleased the former Ralph Lauren flagship at 711 Fifth Avenue and the corner of 55th Street for $5 million annually, 20 percent less than the rent Lauren is paying.

“While we wait for the end of the pandemic, there are a number of new Covid-19 retail operations, including testing centers and vaccine distribution that are temporarily filling retail spaces,” said Lisa Rosenthal, a broker at Compass. “Some retail spaces are being converted to office uses for people who do not want to ride elevators or share a common office lobby. Traditional retailers are slowly coming to the market now, but they’re all being very deliberate about what they are looking for and are holding out till they find what they want in terms of space, neighborhood and most importantly, deal structure.”

Shopping centers are also bearing the burden of store closures. Experiential retailers, which were a key source of demand growth prior to the pandemic, have been forced to permanently shutter locations. “Based on the store footprints of the retailers that have made announcements, we expect malls to be disproportionately impacted by the latest round of closures,” CoStar said. “This will ultimately lead to expanding vacancy rates for malls in the near term.”

Urban stores, which have typically been the most productive units in a chain, lost that status during the COVID-19 pandemic. Nordstrom JWN-1%, for example, whose top-performing locations included downtown Chicago and downtown Seattle, became the first brick-and-mortar retailer to report that e-commerce accounted for the majority of its earnings in the most recent third quarter.

Store openings in 2020 have largely been driven by value retailers, such as Dollar General DG -3.3%, Dollar Tre DLTR -0.3%e, Family Dollar and discount grocers such as Food Lion, Lidl and Aldi since these retailers traditionally target lower-income and/or lower-density areas and aren’t usually found in malls, and Target Corp. is expanding its small-format stores in Manhattan, bringing its mix of style and staples to more neighborhoods.

According to CoStar, major southern growth markets, such as Raleigh, Nashville, Charlotte and Atlanta, where foot traffic has been less affected during the pandemic, are poised to outperform other locales going forward. Retail tenants in markets where projected demographic growth remains below average, such as New Orleans, New York and Honolulu, have seen traffic significantly more affected and may experience an outsized share of closures.

Many major markets in the west are projected to experience relatively strong household and income growth over the next two years. However, some of these fast-growing markets, including San Francisco, Seattle, Denver and Portland, have also experienced relatively dramatic declines in retail foot traffic over the past nine months, which will likely create a longer path to recovery, CoStar said, noting that relatively strong demographic growth in Phoenix, San Antonio and Dallas has produced less-drastic declines in retail foot traffic.

“Finding readily available replacements will be challenging as traditional retailers, which have announced the most store closures, have been unable to adapt quickly enough to the growth of e-commerce,” CoStar said. “Experiential retailers have also been at risk from the direct impact of stay-at-home orders and social distancing.”

“The key to navigating the transition will be in the interim merchandising across asset classes, providing retail options that serve the available traffic of residents and workers in an immediate trade area,” said Abrams. “This will undoubtedly provide valuable opportunities, even if for a limited period of time, for some retailers that couldn’t afford space in the past. A collaborative retail landlord-tenant relationship is more important than ever.”

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