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Retailers Begin To Show Some Signs of Life, But New Leasing Deals Continue To Pose Challenges

As the U.S. economy has begun to show minor signs of improvement, so has the outlook for retail leasing. A number of tenants in the discount, warehouse club and quick-service restaurant sectors are beginning to look at expansion. The fact that there are retailers out there willing to sign new leases should give hope to real estate owners, who have spent most of the past year trying to keep their tenant rosters from falling apart. But getting retailers to commit to a new lease is not easy or cheap, leading landlords to make some difficult decisions about the benefits of filling up vacant spaces to preserve the image of a successful center and attract shopper traffic versus holding out for deals that make sound financial sense.

A recent report from RBC Capital Markets and Retail Lease Trac, a Dahlonega, Ga.-based real estate research firm, shows that 2,000 retailers plan to open 64,926 new stores in the U.S. over the next 24 months. Most of the upcoming openings are attributed to fast food restaurants, including Quiznos Sub and fitness club operators like Anytime Fitness. In addition, some retailers not covered in the report (notably discount operators Wal-Mart and Target and warehouse clubs Costco and BJ’s) have been opening new stores as well, according to Tom Maddux, president of KLNB Retail, a Towson, Md.-based tenant representation firm. Wal-Mart, for example, plans to open between 157 and 177 stores in fiscal year 2010, while Target is looking at up to 30 new stores. Some mom-and-pop shop operators have become more active, too, as less competition from national chains has made it easier for them to break into new markets.

But given how difficult it remains for retailers to get credit from their lenders and how weak the outlook for consumer spending continues to be, these companies are being very careful with their money. If they are to sign a new lease, they need a financially viable deal and that means even landlords with Class-A properties might have to compromise on the terms, says Maddux.

“If a retailer is doing half as many new stores in 2009 as they did in 2007 or 2008, they’ve multiple times more opportunities,” Maddux notes, pointing to the vast number of vacancies created by the bankruptcies of electronics sellers Circuit City and Tweeter and housewares seller Linens ‘n Things. “Specific markets sort of lose their significance as tenants have greater opportunities nationwide. So there might be a major opportunity in a very tight market. But during the lease approval process, if the sales forecast doesn’t support the rent, the retailers feel they might as well go into another market because the profitability model [there] is greater.”

So what does it take to close a new deal in this environment? To begin with, a landlord hoping to get a new tenant into his center might have to offer a discount of 10 percent to 25 percent on the base rental rate compared with the rents secured just two years ago. But for many tenants, that alone won’t be enough, says Bridget Grams, principal with Huntley Mullaney Spargo & Sullivan LLC, a Roseville, Calif.-based real estate and financial restructuring firm. Expanding retailers also want to see tenant improvement (TI) dollars and a period of free rent during the build-out process, Grams notes. So if construction work on the store will take four months, tenants will generally expect to get two months of free rent. If the landlord requires either a corporate or a personal guarantee before agreeing to lease the space, the retailers would like for the guarantee to expire if they show a strong enough performance, she adds.

Some also request not to pay base rent during the first few months of the lease term, insisting that given today’s difficult environment, during initial occupancy they should be able to pay rent based on percentage of sales, adds Eric Hohmann, managing director and head of the West Coast region with Madison Marquette, a Washington, D.C.-based investment, development and management firm. In addition, retailers are looking for leases with shorter than average terms. Whereas the standard in the industry has been 10 years, now tenants want to commit for only five years, with exit options tied in.

Requests for all these extra concessions, especially the TI allowances, have made leasing negotiations much more difficult. In many cases, landlords might simply not have the funds to provide all those perks, says Maddux. They might be desperate to fill a vacant space, but agreeing to put extra TI dollars into a lease that already features a much lower rental rate might actually turn the space into a money loser.

As a result, transactions that used to close in a matter of weeks now take months. "It’s a longer, slower process, a more conservative process,” Maddux notes. “The biggest difference between the summer of 2009 and the last 15 years has been the lack of urgency."

But in a market where vacancies have reached record levels, many landlords might find themselves in a situation where they have little choice. “What we’ve seen in the market is a very rapid change in dynamics, where we’ve gone from a landlord’s market to a tenant’s market. We are certainly not in an equilibrium space,” says Hohmann. “The deals are much less attractive than they were a year ago. But if you want a strong national retailer to go forward, that’s what you’ve got to do. This is probably the darkest before dawn moment in our business.”

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