A Retail Lease Primer for Gift Shop Owners: Survive to Thrive
The recent economic downturn has created a tough sales environment for many retailers, especially the so-called independent “mom and pop” stores and those operated by franchisees. Declining sales due to high unemployment and depressed home valuations have contributed to a feeling of economic insecurity that is reflected in increased savings rates and decreased consumer spending. This all translates into a challenging environment for owners of retail gift shops.
Shopping center owners are seeing historically high vacancy rates due to store closures. A Wall Street Journal article in early April cited vacancies in enclosed malls at just below nine percent and just shy of eleven percent in neighborhood and community shopping centers (such as those anchored by a grocery store). These are the highest vacancy rates since the recession in 1991. While that’s bad news for them, it’s potentially good news for gift shop owners who are managing to weather the downturn.
Rental rates have declined due to increased vacancy and increased inventory of new shopping center space that came on-line as the economy dipped. Tenants who leased their space between 2005 and 2008 are paying especially high rental rates. Over the last year and a half many multi-unit, national chains have aggressively renegotiated their rent as well as other lease terms, some as a result of a decrease in sales, others to simply take advantage of an opportunity to reduce occupancy costs and reposition themselves for increased profitability both in the short and long term.
What does this mean for the gift shop owner? Those who have a good concept, contribute to a strong tenant mix in their shopping center, have operated responsibly and can demonstrate that their business model is sound have a great opportunity to either reduce the rent at their current location, relocate to better space in the same center, or relocate to a stronger shopping center in a superior market area. A good way to think about what’s key to address in a new lease (or what to renegotiate if you have an existing lease) is to focus on the lease terms that are most likely to impact your “top line” sales potential and your “bottom line” profit.
In addition to the quality of the products and/or services you offer, the location of your store is a key top line sales driver. Implicit in that are several factors that are important to distinguish when you are selecting your new store location or if you are considering a relocation of your current store. Remember that when you are signing a lease you are not just leasing a space for your store, you are buying into a shopping center that serves a market area that may or may not be right for your type of business.
So where the shopping center is located, what type of center it is, and who the anchors and co-tenants are will impact your store’s sales potential. Are the demographics of the people who live and work in the area around the center right for your store (i.e. are they “middle market” or “higher income” families)? Is the center a “neighborhood center” with a traditional grocery store anchor and other “daily needs” tenants (who typically only draw from 1 to 3 miles away)? Or do you need more customer pull than that? Are there shopping centers with anchors that draw customers from further distances? Do these anchors and other co-tenants target the same customer as you do? Is there good car or foot traffic in or near the shopping center? Is the center active when you need it to be? Are customers lingering and taking their time when they are shopping (and making discretionary purchases)? You want the right market area, the right center and the right mix of tenants to support your business.
The following is a list of key items that impact your top line sales that should be addressed in your lease:
- Shopping center anchors (identify by name)
- Co-tenancy requirements (identify by name)
- Allowable vacancy percentage (can trigger rent reductions or termination rights)
- Site plan requirements (location of other tenants, access, parking lot size and layout and number of stalls convenient to your store entrance)
- The location of your space in the center and in relation to other key tenants
- Exclusive for your use (limits competition)
- Allowable signage (type, location, size and number of signs)
- Rights to use exterior spaces such as patios or sidewalk areas adjacent to your store
- Length of term of the lease and option to extend the lease (how long you control your space)
- A right of first refusal to move to a more desirable space in the center
- Limiting the Landlord’s right to relocate you to another space or terminate your lease.
The bottom line lease issues are generally easy to identify:
- Annual base rent (your rent per square foot)
- Common area expenses (based on the total square footage of your space divided by the total leaseable square footage of the shopping center)
- Real estate taxes and insurance (on your space)
- Shopping center marketing contribution
Each location has its unique particulars so there may be others, but these expenses are the standard items that make up your “occupancy cost.” It is critical that occupancy cost be reasonable based on your business model because they are fixed, that is, they don’t vary with your sales. What’s reasonable? Generally speaking, occupancy cost should not exceed 10-12 percent of sales for businesses less than 1,500 SF. Anything higher than that and you decrease not only your bottom line profit but you may put your business at risk if you have a significant decrease in sales. This is in fact what has happened recently to businesses that over reached and agreed to pay high rents based on optimistic sales projections. It’s also important to note that as the size of your store increases, the acceptable occupancy cost percentage decreases.
Depending on where you are located, new tenants are now signing leases anywhere from 20 to 40 percent below rents paid by tenants just a few years ago. It is truly an extraordinary time for small tenants to be able to locate (or relocate) to prime shopping centers in prime spaces under reasonable terms that until just two years ago could only be obtained by multi-unit, national tenants with real negotiating clout. At this time, analysis is suggesting that rents will likely continue to decline slightly or stay flat until 2012.
So what if you want to try to renegotiate with your current landlord? The base rent you are paying is obviously a good place to start. You can easily find out what your landlord is charging new tenants for comparable space, and you should survey surrounding centers for the same information. You may get “rent relief” (a short-term reduction or waiver of rent) which is usually limited to a short period of time or until you reach a certain level of sales. Ask what the landlord is doing to help the current tenants, such as additional marketing initiatives or giving the center a cosmetic facelift.
Finally, don’t overlook reading the details of your current lease. You may already have the benefit of reduced rent due to vacancies in the shopping center, or there may be other terms that the landlord is violating which will give you leverage in your renegotiations. If you do approach your landlord for a base rent reduction, don’t forget to include items from the “top line” list included earlier in this article. When your sales rebound they will help ensure your store’s continued success.