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Retail REIT Executives Not Banking on Marked Improvement in Rent Spreads for 2010

Rent has been a hot topic among retail REIT executives as fourth quarter 2009 financial reports continue to roll in. Across the board retail REITs have reported challenged NOIs in looking back on 2009, driven by declines in occupancy and continued rent pressures.

Many of the strategies shared by retail REIT execs focused on the balance act between securing the best retailers -- and the best rent.

"When supply is tight and demand is high, the last spaces to get leased at a shopping center are all about the rent. This is not the market today," said David Lukes, COO at Kimco Realty Corp.

Dennis Gershenson, president and CEO at Ramco Gershenson Properties Trust, is seeing "a renewed interest by national retailers in opening stores in the best positioned centers," however; this has yet to translate to positive rent spreads. "This is not to say that rental rate negotiations have swung back in favor of the landlord. Instead, we expect that tenants will use the current difficult economic climate as leverage for more favorable rental structures," he said.

At Inland Real Estate Corp., president and CEO Mark Zalatoris said, "Unfortunately, filling vacancies created by the big-box bankruptcies has taken longer, as supply of available retail space has increased and retailer demand has contracted. We made the difficult, but practical, decision to sign [some] replacement leases at rates lower than pro forma rents. However, those deals were executed with credit quality retailers that in an addition to paying rent, will also pay their share of shopping center operating expenses. In addition, the centers will benefit longer term from the improved tenant quality."

Brian Smith, chief investment officer, said that Regency Centers has been able to produce rent growth on renewals, while rent spreads on new leases have been negative. "Renewals have been a relative bright spot and should continue to be." Smith explained, "If you assume market rents are $22 per square foot, and current rents in the center are $26 per square foot, a new lease would most likely be signed at the lower rent for $22. However, chances are that the renewal will be executed at the higher number of $26. Successful retailers are understandably reluctant to walkway from sizable investment in their stores or to disrupt established shopping patterns."

Inland president and CEO, Mark Zalatoris explained why he believes taking a hit on rental rates to get the best tenant has been the preferred strategy,

"While market realities have dictated reduction in rental rates, there is an obvious accretion in replacing lost income, which includes the tenants' reimbursement of real estate taxes and operating expenses. Offsetting these rental declines is the prospect that, with better retailers and increased consumer traffic overall, retailer demand for our centers will continue to increase."

"If we lose a store, versus retaining it, then we get downtime and sometimes we have to make an additional investment to refit the space. So even though we don't like the fact that we have negative lease spreads, we're a lot better off working to retain the tenant," said Stephen Lebovitz, president and CEO of CBL & Associates Properties.

"We're competing heavily with other centers in the trade areas. What we're doing now is setting the table for growth by actively selecting the right tenants, so that the line up in foot traffic is the first choice for future leasing," said Lukes at Kimco. With the high number of junior anchor and small shop vacancies created during the recession, Lukes said that landlord have three choices -- "wait for a better day, sign the highest rent payer or sign the best tenant." Kimco believes that signing the best tenant, even if it's at a lower rent than ideal, is the best choice. "The shopper always follows quality tenants and the faster we can secure the best tenant lineup, the better the prospects for growth are on remaining vacancies. Tenants follow traffic and rent goes up with sales," explained Lukes.

Regency Centers CEO Martin Stein said, "I think today the focus is on getting the right tenant in there sooner rather than later. To the extent that we feel like the space is being leased at a rate that is below where we expect rents to be in several years, we are either starting rents at the lower level or signing short-term leases."


Lebovitz said that CBL has been signing more leases at shorter terms (three years or less) than usual.

"We've done shorter terms so we're not locked in at the lower rates," said Lebovitz. As a trade-off for agreeing to shorter terms and lower rental rates, Lebovitz said that CBL has a checklist of items they might negotiate to make the lease a win-win for both parties, including improving the percentage rent and the breakpoint. When retailers' sales improve, CBL's chance to sign leases at higher rents will improve. Additionally, "As sales pick up, then we'll benefit from percentage rent as well," he said.

At Regency, Stein explained that the tables seem to be turning again in terms of what retailers are willing to give up in order to get lease concessions.

"In the past, whenever we were giving concessions to the retailers, we always got termination rights and we held those concessions to very short terms. Now, the retailers appear to not be willing to enter into those kind of lease modifications because they don't want the risk of losing the store. They are looking more long-term," he said.

Stein added, "They've survived this long; which means they've got a loyal customer base and they don't want to risk that. And frankly, we are seeing a lot of people talking about how they are not able to get any TIs at other centers and the lenders aren't keeping up the centers. So there is not only reluctance not to leave, but we're getting a fair share of people wanting to move into our centers because they know we take care of them."

Since demand has improved somewhat, so has retailers' requirement for tenant improvement allowances, said Lukes at Kimco. "TIs have definitely pulled in a lot from six to eight months ago. Where that might be different is if the building is very old and needs to have a lot of work done to it," he said.

At Inland, Scott Carr, president of property management, said when it comes to expectations for tenant improvement allowances, he hasn't seen a significant change in what national tenants request, but small shop tenants are requesting landlord participation more than in the past.


Zalatoris said that Inland has seen the amount of rent relief requests decrease significantly, but added that smaller, "Mom 'n Pop" tenants remain under pressure. CFO Brett Brown added, "We've definitely seen a slowdown in the requests and we've always taken the aggressive posture in responding to them. With our Mom and Pop tenants, the ultimate price that we extract is a right to recapture their space. That's a tough decision for someone who has a successful business that just needs to carry them through. We're finding a lot of those Mom 'n Pop retailers seeing the light at the end of the tunnel and even backing off with some requests when we put them to that ultimate test."

"When a struggling small shop tenant's prospect for success appears limited, and given the decline in the formation of new small shop startup retailers, we often look to competing centers for replacement tenants," in dealing with such situations, said Zalatoris.

Michael Sullivan, SVP of asset management for Ramco said rent relief requests have gone "down to a trickle."

"Requests for rent relief are down substantially," said Coppola. "A year ago at this time, I think while nobody knew exactly where the failures were going to come, people were relatively convinced that they were coming. The profitability of retailers overall in our portfolio has dramatically improved [in comparison to] one year ago today, so our anticipation is that rent relief requests are going to be way down and unexpected failures will also be down from what they were last year."


In addressing whether or not "market rent" has bottomed out yet, Stein at Regency said, "In most markets, it has bottomed. Obviously a lot of the rents that are out there have to reset to the new market, but it has bottomed. There are exceptions for that -- I don't think we've seen it in the deserts; but I think pretty much everywhere else, we feel bottomed and that the retailers would tell you that they've hit bottom."

At Inland, Carr said, "I would say we are closing in on a bottom, because we've dropped pretty far," adding that 10% to 50% drops have been observed, depending on the sub-market and spaces involved. He thinks the bottom has definitely been reached on small shop rents. "Retailers realize that they can only go so low if they are going to have a viable landlord that can participate in a deal in terms of building out space and TIs," said Carr. In looking ahead, Carr said that opportunities to push rents on renewals and new leases are just starting to peak through, but overall, we should not expect the trajectory of rents trending up to happen even nearly as fast as the trajectory coming down has been.


Kimco said that fourth quarter 2009 brought a "large uptick" in small shop leasing activity, and while rents were "wildly divergent" depending on the characteristics of their respective markets, in aggregate, new leases signed were still slightly higher than the previous tenant in the space.

Demand has also improved for junior anchor space, said David Henry, president and CEO at Kimco. "A lot of retailers are now submitting Letters of Intent on junior anchor spaces that four or five months ago had no activity, but I certainly wouldn't expect the rent spread on the junior anchors to improve" soon, he said.

Inland said it is seeing an improvement in leasing activity. "The leasing velocity we are now experiencing and the quality of tenants with whom we are dealing, indicates that we are building a strong foundation for restoring occupancy and growing rental income within the portfolio," said Zalatoris.

Arthur Coppola at Macerich said while his firm isn't banking on it, he is hopeful that the recent increase in retailer interest will lead to an improvement in occupancy and rents spreads this year.


At CBL, Lebovitz said that during 2009, retailers definitely had the upper hand in negotiations, but "as the economy improves, we will be able to get back to where we were, or even better with the retailers." Additionally, the lack of any new development puts landlords in a better position going forward, especially those that have made improvements to their shopping centers during this recession. That being said, Lebovitz does not believe rent spreads will improve dramatically this year, as the priority remains signing leases and improving occupancy.

Smith at Regency said, "Retailers are still struggling. Tenant failures and move outs remain a concern and pressure on rents is expected to continue until occupancy rates return to levels previously seen. This is particularly true in 'green' areas where [population] densities are light."

At Simon Property Group, David Simon said, "Part of what we'll suffer for in 2010 is the deals we did in 2009. When we did them, the retailer was feeling a lot worse about things than they are today," said Simon. However, retailers remain intensely focused on expenses and rents and continue to close stores. "2009 was a challenging year in the retail real estate world and 2010 is going to be a challenging year, too," he added.

Addressing when he expects rent spreads to return to historical norms, "I don't think we can get to historical numbers until there's a stronger economy and stronger demand from retailers," said David Simon, adding that we're not in that environment yet. On the heels of this comment, Richard Sokolov added, "sales, cash flow and profitability have been substantially better for retailers," so that will work in landlord's benefit for negotiations in 2010, he said.

Looking ahead this year, Zalatoris at Inland said, "While showing signs of the improvement, the operating environment for retailers still remains challenging. We expect additional re-entrenchment in certain retail segments this year and potentially some national chain failures as well."

At CBL, Lebovitz said, "As retailers reformulated their business plans in 2009 to focus on controlling inventory levels and reducing cost, they reported improving margins and better profit ability. Despite the negative sales comps today, many of these retailers are better able to [manage] current occupancy cost, which goes well for the easing of the rent pressure, as we progress through 2010." 

Information provided by CoStar.

Posted - 4 days ago

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