Keeping properties vacant can be less risky than refusing to lower rents
Alistair Gray and Judith Evans
Vornado's decision to compromise and cut Forever 21's annual rent at its Broadway store stands out in the retail industry © FT montage / Bloomberg
When Forever 21 was struggling to pay its bills last year, the cheap chic retailer’s landlord at Times Square in Manhattan was so determined to keep the store open that it slashed the rent, making the one concession building owners try to avoid.
As part of a deal with Forever 21 after the company filed for Chapter 11 bankruptcy protection, Vornado Realty Trust more than halved the $20m in annual rent it had been demanding for the celebrated site on Broadway and another prime space in Midtown.
Vornado’s decision stands out in an industry that can be so unwilling to compromise on price that it sometimes prefers to let site incomes drop to zero as retailers vacate unprofitable stores.
Despite thousands of closures across America that have pushed vacancies in shopping malls to their highest level in at least two decades, overall retail rents are still creeping up.
“It’s a head scratcher to me why some landlords are not willing to do more in terms of rent concession to prevent companies from having to file for bankruptcy,” said Mohsin Meghji, chief executive of M-III Partners, a restructuring firm that handled the bankruptcies of Sears and Barneys.
Real estate executives said the calculation was not always so simple. Landlords have a lot to lose by making compromises with stricken tenants and there can be sound business reasons for leaving properties empty.
Steven Soutendijk, executive managing director at real estate services group Cushman & Wakefield, said that those unfamiliar with retail real estate may “look at vacant retail stores the way they’d look at one-bedroom apartments — that if a landlord has a vacant space and cuts the rent, it would get rented within 30 days. It doesn’t work that way.”
Rent typically comprises only about a tenth of retailers’ costs, making landlords sceptical that reductions are enough to fix broken businesses. Shoe retailer Payless, for instance, filed for bankruptcy in 2017 even after securing what it described as “significant” rent concessions.
Jaime Ward, head of retail finance at Citizens Bank, said there were cases in which “it doesn’t matter what the rent is. If you lower it to zero, they’re probably still not going to make money.”
The length of retail leases, which traditionally last at least seven years, makes owners particularly reluctant to lock in tenants at depressed levels.
At higher-quality properties, landlords risk damaging the image of the mall or street if they accept the first willing replacement.
“A Dior, for example, would not want to be between a hair salon, a recruiting centre and a mini golf course,” said Vince Tibone, analyst at California-based property advisers Green Street.
Some anchor retailers have lease clauses that give them approval rights for tenancies elsewhere in the same shopping centre.
Owners also worry that accepting lower rent at one mall unit will encourage other tenants to make similar demands.
Ultimately, reducing the rent can force the owner to write down the value of the property. An empty space may be temporary but a tenant signing up at a lower rent is proof the property is worth less than it was. The cash required to take on new tenants, from brokerage commissions to store refits, also makes some pause.
While landlords insist they are not being delusional in leaving properties empty, the apparent refusal of some to be more accommodating on rents stands in contrast to the global financial crisis and its aftermath, which is the last time mall vacancy rates spiked. Asking rents fell for seven consecutive quarters after the collapse of Lehman Brothers in 2008.
At more than $45.50 per square foot the average asking rent for non-anchor mall tenants at the end of 2019 was the highest on record, according to Reis Moody’s Analytics.
Away from hard-hit malls rental costs at some sites have spiralled. Barneys New York was tipped into bankruptcy after the luxury department chain said the owner of its flagship store on Fifth Avenue demanded millions of dollars worth of additional annual rent.
The 4,450 announced store openings across the industry last year was less than half the 9,300 closures, according to Coresight.
With more retail failures on the cards property analysts are expecting more owners to buckle in the months ahead.
“It keeps the space occupied, paying rent,” Michael Franco, president of Vornado, said as he explained its decision on Forever 21 to Wall Street analysts in October. Forever 21’s lease term was also shortened as part of the agreement.
There are signs that some owners are not only reducing rents, but are being more flexible with lease terms, offering more temporary “pop-ups” or variable payments based on sales.
“Everyone is now more open to being more creative,” said Richard Johnson, a partner at Odyssey Retail Advisors.
“Our business is a supply and demand business and anyone who doesn’t understand that is foolish,” said Jeffrey Gural, chairman of GFP Real Estate, whose portfolio includes iconic New York properties such as the Flatiron Building. “If there are a lot of vacant stores then rents should go down.”
While the headline figures indicate rents remain elevated, the overall statistics do not tell the full story.
Asking retail rents eased in almost 30 cities in the fourth quarter, according to Reis, including Detroit, Indianapolis and St Louis.
Figures from Cushman & Wakefield show they are also under pressure in some of the most prestigious addresses in Manhattan. On a stretch of Fifth Avenue between the Rockefeller Center and New York Public Library, asking rents are down about 17 per cent year on year.
The figures also capture only rental demands — not what tenants actually pay. “On the ground, actual taking rents are down substantially over the last 36 months,” said Mr Soutendijk of Cushman & Wakefield.
Research group Green Street forecasts rents at the 100 best-performing malls to increase moderately over the next five years but to dip in weaker properties. Across the US market it expects rents to decline “for the foreseeable future”.
Penalties for empty storefronts
By leaving storefronts empty, landlords are not only forgoing rental income. They are also risking a backlash from officials who regard vacant retail space as a social scourge as well as a business issue.
Arlington in Massachusetts hits them with penalties. Ali Carter, economic development co-ordinator in Arlington, said the town of about 45,000 decided to act after 17 units on a single block were left unoccupied.
While the fee is only $400 a year, she said its introduction two years ago had been an effective deterrent and there were now only three vacancies. Some landlords, she said, “really needed a stick, not a carrot”.
Matt O’Malley, a city councillor in Boston, is calling for the city to enact a similar system. “We’re not seeing enough action to address the problem.”
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