Store rents challenge chains
Retail occupancy costs could be a problem for retailers seeking rapid expansion in the U.S.
During a panel discussion at the recent NRF Big Show on shopping center development, David Zoba, SVP global real estate and store development at Gap, Inc., said, "Rents are a challenge in the U.S and are reaching a point of rent/occupancy cost levels that will cause a lot of retailers a crisis, clipping growth. We can’t pay these rents and have a viable business."
William Taubman, COO at Taubman Centers, Inc., supported Mr. Zoba’s assessment by noting developers "have been driving rents to record heights."
According to Reis, a research provider on commercial real estate performance and analysis, asking rents for regional malls grew 1.8 percent during 2014, and rents have increased every quarter over the past four years. In some major markets, last year’s rent increases exceeded the national average by a substantial margin. In San Francisco, according to Reis, rents rose 4.3 percent last year, Phoenix, 2.5 percent and Miami, 4.0 percent.
Prime real estate is through the roof. For example, on New York City’s upper Fifth Avenue, the average rent per square foot is $3,500, according to Cushman and Wakefield. This represents a 13 percent increase year over year.
The relentless growth in occupancy costs was attributed to several causes. Retail growth has been sluggish and only now beginning to experience a resurgence. At the same time, e-commerce has become a much stronger factor at retail and the correct balance between online and bricks-and-mortar has by no means been ascertained.
In addition, the U.S. market is overstored as well as being over-spaced in terms of shopping centers and malls. There has been no mall construction except expansions of existing malls. Vacancy rates are low, and for top malls, vacancies are non-existent. For these reasons, landlords have considerable strength in pricing power. Moreover, continued improvement in the economy and wage gains may means that rents will continue to increase.
Discussion Questions
Will rents curb retailer plans for expansion and hurt sales and profit growth in the coming year? What strategies are open to retailers to maintain expansion and growth? What factors could slow increases in store rents?
Topically, I just read that HEB supermarkets is preparing to operate a 12,000 square foot store in an urban area of San Antonio. They talked about the challenge a format about one-tenth the size of their larger stores presents.
For the reasons this article presents and others, I believe you will see a real push for smaller formats and a much different approach to assortment and merchandising for these smaller stores.
Clearly the consumer acceptance and the technological feasibility of augmenting the brick-and-mortar experience with online ordering will enable retailers to test formats where fresh product and staples are available in a physical store, but less-frequently purchased items will not be in stock but can be ordered and either be picked up at the store or sent directly to the shopper’s door step.
This does not mean that large box stores are going away, just that their growth will slow significantly in favor of smaller, more profitable footprints.
Vacancy at the high end is low, and that’s where landlords will have leverage. For the rest of retail, there is still plenty of space and little leverage to increase price.
Sure if we all got free rent, expansion would be so much easier. Retailers seeking rapid growth have lot more issues than just rent. Maybe not being able to afford the rent is a warning sign that you don’t have a viable business and rapid expansion should not be a priority. Unless the economy tanks, rents should continue to rise as they should. I work with a few retailers that will own their own buildings to avoid the rent issues. I have never seen a retailer that owns all their real estate go bankrupt. It limits growth but it also limits making mistakes.
There is a huge difference between prime retail space and retail space. Where the location is a destination rather than a particular store, rents will continue to rise. Otherwise, rents will go the way of retail sales, flat to up up 2%.
The U.S. continues to be over-stored versus the rest of the world. Online is growing while brick and mortar is lagging. Demand for retail space will drive rents. In the long run retailers will find that they can generate as much revenue (omni-channel) out of a smaller footprint.
It is interesting that not too many years ago we were asking how all the vacant space would be rented, who was going to rent it and how the landlords were suffering. Isn’t it amazing what a few years and good economy will do?
As Mark cited with the HEB example, retailers are finding they can profitably operate selected sites with less variety (using the 80/20 rule) and therefore less space is needed. Others doing this by moving to buy online/deliver to home and/or buy online and pick up in store models. Smaller is becoming become the new big.
Retailers plans for store expansion? I believe it’s going the other way. Mr. Zoba sounds like he’s deflecting the fact that Gap will be closing several stores in the coming years—as will all retailers.
Traffic has been steadily decreasing for years due to eCommerce, and that’s not going to change, so I’d say, let them raise the rents. The only tenants they’ll have in the future will be retailers that completely get it, like Apple or Warby or Shake Shack—at thousands per square foot, they’ll be the only ones who can afford to be open. Sounds like Darwinism, which is of course, the core principle of retail.
This is a bubble that is going to burst. Prime malls will command premiums as always, but some retailers business models won’t allow that kind of rent cost. With upwards of 30% of sales going online, and net total sales not growing anywhere near that rate, retailers are going to have a lot more unproductive stores in non top mall locations. If the costs of those stores goes up, they will over time be abandoned either through non renewals, or bankruptcies. Those malls will end up being a burden to the fewer retailers that are left, and will end up closing.
At some point the retail square feet and the sales in retail at brick and mortar will have to balance out, and the only way that happens is through a lot less available square feet. So no, raising costs to retailers in non prime malls will just accelerate the death march for those unexceptional malls.
The effects of high rent and/or ownership on the economy is a great discussion topic and needs more exposure. This single business expense is having a largely negative impact on those businesses willing and able to expand. As we move further away from long-term static location commitments to address market expansions the real estate portion of retail is falling further behind in it’s ability to keep up with the market.
A close examination of the retail business will show that there are many mouths to feed in any transaction. And most of them are priced beyond the realm of what is or has been supplied. Dealing directly with the owners and using your own banks and legal will move down a lot of the costs and at the same time make per square foot negotiations far easier.