Retail Rent: How it will play out

There has been quite a bit of press about landlords not being flexible about rents – and that this is untenable. Locally Mark McInnes has been vocal about this and when retail royalty like Mickey Drexler starts talking about this, then it is worth exploring because it is not simply an Australian issue.

There is a scary, but  good article by Gottliebsen on Business Spectator (with a graph) that is worth a read.

I will present a few arguments for both sides. I am not picking a side, NOT because I don’t have an opinion or am afraid to share it; but because I think there is more value to be had in each party understanding the other’s point of view – and most importantly, what follows after.

Retailers are wrong

  • The lease is a legal document like any other and can and should be enforced because the alternative is chaos.
  • Retailers have been crying poor all along – why should we believe them now?
  • Changing business conditions is a business risk – and it is not appropriate to expect the landlord to wear the business risk; it should be borne by the business.
  • Retailers are taking the ‘easy’ way out – simply targeting the biggest expense and trying to reduce that instead of focussing on Sales and Cost-of-Sales which will both have a bigger and more sustainable benefit. (To be fair, DJs and Myer are trying to reduce COS.)

Landlords are wrong

  • Leases that run for 5 years are anachronistic in a time where change is rapid and the agreement denies the lessee the flexibility to survive.
  • Whilst the business risk should be borne by the business; when critical numbers of retailers begin defaulting, then that becomes your business risk. Action cannot be postponed until this happens – and it is easy to miss the tipping point. (In fact it will probably be missed.)
  • Landlords have limited options to mitigate their own risk. It is difficult (time and money) to reinvent the shopping centre in the event of the calamity that is 20%- 50% vacancies. But because it is difficult does not mean do nothing is an option.

This is not meant to be a comprehensive list of reasons (add yours in the comments) but simply to highlight the fact that there is (as always) two sides to a story.

Importantly, there are two observations I can offer:

For Retailers

I do a lot of work for one (very good) landlord/manager and I can say that they are definitely open to discussion and proactively seek remedies for critical situations with the independent specialties. (There may be individual exceptions at a centre level, but I doubt that any major landlord/manager ignores this as a rule.)

The biggest obstacle I face during the turnaround process is that 100% of the time (and I am not exaggerating, it really is 100%) the retailer who is struggling is also the one that cannot produce a current, accurate set of financials or a current set of reports from their POS.

There are several other (related) symptoms and they can be reduced to the simple fact that the operator is not in control of the business.

If you do want to have a discussion with your landlord/manager, you must:

  1. Have all the information at your disposal, and be willing to share it. (If you want to share the risk, you have to play open cards.)
  2. Be able to demonstrate that you have executed alternative strategies to improve sustainability.
  3. That you have a plan of action of how you will leverage the possible rent relief. (This is different for everybody.)

Unless you can do this; the landlord/manager has every right not to share your business risk any more than they already do.

For Landlords

The current retail climate is a function of a cyclical dip (driven by GFC/ Euro zone crisis etc.) AND a fundamental structural shift (driven by eCommerce, social media etc.) It is the ‘perfect storm’ if you will.

Australia has been somewhat spared through a bit of luck, or isolation and the resources boom. But it is going to get worse before it is going to get better. We will come out of the dip – but some other changes will continue.

This claim for rental abatements will become louder, and it needs a whole-of-portfolio response. In the 2000s it was possible to deal with rental structures on a case by case basis – and it was relatively easy to replace a failed tenancy with another.

This response must include:

  1. Some visionary work to start re-imagining shopping places. (And this will have to be radical – like revisiting some ideas like Psychogeography which may have been ahead of its time.)
  2. Some immediate, short term strategies to support the transition retailers have to make – and this may include rental abatements.

If you wait until the retailers fall over, it is obviously too late – it goes without saying.

And finally, there is not much to be gained by either party blaming the other of incompetence or intransigence or whatever.

Both parties are right, so the problem remains.

This is how it is going to play out:

The lag between economic reality and the term of the lease is being wiped out as I write this.

If the average specialty lease term is 5 years, then the mean time to renewal is 2.5 years. That is about when the GFC first struck, so every rental renewal from about now onwards in the majority of categories will become a battle.

For the retailers:

  1. Some retailers will get a sustainable deal.
  2. Some retailers will walk away.
  3. Some retailers will reinvent themselves.

For the landlords

  1. Rents will drop and there will be fewer (or worse) replacements.
  2. There will be higher debt and higher vacancies (softer yields)
  3. The retail mix will suffer
  4. Some centres will reinvent themselves and grow stronger

I am not telling you anything new. I am simply describing the cycle of life (and death) in this particular economic corner.

But what I am attempting to do is to remind you that the only thing that is in your control is the decisions that you make about your business.

Whether you are a retailer or a landlord, the cycle of life will produce winners and losers.

And it may be unpopular and confronting to say so, but this is a matter of choice.

I can’t tell you what the right decision is for your business, but here is the strategic process you should follow BEFORE you review/renegotiate your rent.

  1. What business are you in? (Read this article on why Kodak failed, but importantly read a colleagues comments too…). Google the phrase until you find the original HBR article in the early 60’s and start from there. If you can’t answer this, everything else is a waste of time.
  2. Is there a market for your business? (You can also start here if you are entrepreneur and you are able to create a business based on the need. Most people are already in some kind of business/ market/ industry, so this question is your GO/NO GO filter.)
  3. Figure out whether you need a new proposition - explore the link to understand what that means.)
  4. Figure out how to tell your story. (This is the marketing part – but it is NOT about promotion or advertising.) The key word is ‘story’ – and you must ‘get’ that.
  5. Execute and measure.
  6. Repeat 2-6