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More Bad News for Retailers: Rising Rent

Mall retailers are getting that can't-catch-a-break feeling. With sales just this side of mediocre and the future unclear at best, the last thing they need is higher rent. Yet that's what a lot of them are facing at the country's top malls.

Mall rents are heading up as demand for prime mall space continues to grow. According to commercial real estate information firm Reis Inc., asking rents at regional and super-regional malls rose 1.7 percent in the third quarter of 2002, to an average of $36.16 per square foot. At Chicago-based mall REIT General Growth Properties, leases signed or renewed in the first nine months of 2002 carried an average square-foot rent of $34.75, up $4.85 from the average expired lease.

“Demand for retail space is remarkably strong in a relatively weak economy, and part of that has to do with the fact that there isn't a lot of new mall construction,” says Paul Morgan, a real estate analyst and vice president at Thomas Weisel Partners. “That's keeping occupancy and spreads steady.”

Most retailers are taking the hikes sitting down. Reis reports that vacancy rates at the regionals and super-regionals crept up only slightly in the third quarter, to 6 percent from 5.8 percent, and the REITs report a strong rate of lease renewals.

But the rise in rents “can't keep up forever in the face of slackening sales,” notes Morgan. “If sales don't turn around, the REITs will start to see pressure on rents. There are limits.”

Indeed, some analysts wonder how long struggling retailers can continue to pony up more money before they decamp for the less chic environs of strip shopping centers or more upscale lifestyle centers.

Current rent hikes may be “a kind of watershed for retailers, in the sense that they will have to begin to consider seriously what the advantages are to being in the mall,” says Kurt Barnard, president of Barnard's Retail Consulting Group in Upper Montclair, N.J.

Executives at mall REITs express confidence that retailers will be able to handle higher rents because, they say, tenants have gained efficiency and gotten better at controlling inventory and expenses in recent years. Besides, the wholesale cost of some goods has decreased — apparel retailers, for instance, are paying 2 percent to 3 percent less than they were a few years ago, says General Growth Properties COO Bob Michaels.

Higher rents will, of course, be less of an issue if retail sales head substantially higher in the first quarter and beyond. “Retail sales are not going to stay depressed,” predicts Richard Knitter of Great Realty Advisors in Oak Brook, Ill. “The overall picture is that they have been going up, and there's no reason to think they won't keep going up. I don't think sales will go down in class-A malls.”

But if sales do remain tepid, many retailers will handle the higher rental expenses “with great difficulty,” says Barnard.

“We are dealing currently with an economy that is rather difficult and a consumer spending climate that does not encourage me to feel that retail sales are going to escalate in the foreseeable future,” Barnard says. “After all, retail sales and consumer spending depend on a four letter word — jobs — and the outlook for jobs is not exactly flamboyant.”

Barnard adds that a lot of retailers are searching hard for ways to lower operating expenses without losing customers. For some, leaving the mall is becoming a more attractive option.

Dollar Tree Stores was an early adopter of that idea. Almost a decade ago, says Bob Gurnee, vice president of real estate for the Chesapeake, Va.-based chain of 2,200 stores, “We made a decision to concentrate more on strip centers. Rents were anywhere from $5 to $10 lower per square foot, than in malls. More recently, Gurnee says, Dollar Tree decided to shift entirely to strips, although it still has about 250 mall stores. “We simply do better in strip stores,” says Gurnee, “and it's more expensive to operate in a mall.”

Leading specialty retailers, however, are not likely to move to supermarket-anchored neighborhood strips. But they could leave malls for upscale “lifestyle centers,” which continue to proliferate. According to the ICSC, the average base rent per square foot for a lifestyle center is $33. That's a small discount off the regional mall average, but higher than an $8.27 average at strip centers and $7.83 per square foot at community centers.

What could hurt retailers more than rent increases, says Tom Dwyer, manager of retail solutions at Reis, is the tendency of chains “to boost numbers on the top line by going for more stores and worrying about productivity later. That's a formula for disaster. I certainly don't believe that a lot of retailers can sustain all the stores they're opening in malls.”

Barnard agrees. Despite what the mall REITs say, he says he doesn't believe retailers have come anywhere close to achieving the efficiencies necessary to compete with discounters like Kohl's.

So, is the day coming when more retailers are forced to forsake their prime spots in favor of a location a little more downmarket?

“In short order, it'll have to happen,” Barnard says. “Stores that are not in the malls are going to eat their lunch.”

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