Despite the gradually improving economy, there's still too much retail space begging for tenants. That means your landlord may need you more than you need your landlord. And that can translate into lower rents.
The nationwide vacancy rate for retail space has climbed to 11.0 percent, the highest level since the mid-1990s, reports Robert Bach, chief economist at Grubb & Ellis, a commercial real estate services company based in Santa Ana, Calif. That's much higher than retail's six or seven percent "equilibrium rate" — the level at which rents increase by no more than inflation.
"Retail leasing market conditions are soft," says Bach. "And that means retailers can get better deals on their space."
Retailers are taking advantage of their leverage, according to 2011 Forecast, a new report from Grubb & Ellis. Retailers have been repositioning their outlets, "often moving up to better centers that were too pricey before the recession," the report notes.
Rent Reductions
The time to strike is now. Most real estate observers say that the vacancy rate is pretty much as high as it's going to get. Indeed, in some markets the trend has leveled off as retailers start looking to expand.
"While 2011 should continue to be a renter's market, we seem to be at a turning point," says Jeffrey Allen, director operations at Trendant Consulting, Salt Lake City. "We expect to see a slow and steady decrease in vacancy rates through the end of the year."
So what steps can you take to capitalize on the favorable market? For starters dust off your lease and take a fresh look at the numbers, even if your renewal date is still some time down the road.
Maybe your first thought is to ask for a reduction in the monthly rental rate. While that's not out of the question, another tactic is more likely to bear fruit with the same bottom line results: Free rent for a determined number of months.
"Landlords don't like to reduce rent," explains Andy Fried, director of the Small Business Development Center, Coles College of Business, Kennesaw State University, Kennesaw, Ga. "Many landlords buy real estate for investment purposes so they want to keep what they call the 'capitalization rate' up. The higher the rent roll the higher the value of the building." To maintain their investment, landlords will often opt to grant free rental months rather than cut the official rental rate.
Do Your Homework
Knowing your market is the key to success in lease renegotiation. Do your research and line up your ammunition. You will want to answer two questions: What rents are others paying? And what space is available for you to move to?
Here's where the right help can make all the difference. "The No. 1 factor for successful negotiating is having a great real estate agent," says Allen. "Go with the best commercial agent in your area. That person will know what's negotiable and what's not, and will already have a lot of connections with business owners and will know their issues. It all stems from that."
How do you find the best agent? "It becomes pretty obvious once you start looking around and talking with other business people," says Allen. "Call brokers and ask for the name of their top commercial real estate agents ranked by sales volume. Look at advertised listings and scout around for the 'for lease' signs in your area. Whoever has the most signs is often the best agent."
Negotiating Tips
What are the best techniques for negotiating a better deal? "The No. 1 factor is strength of the tenant," says Mike Parkinson, a director at Retail Focus, an international consulting firm.
If you are a tenant in a secondary market a threat to vacate on renewal frequently works, adds Parkinson. "You might also consider taking a lengthy lease term, say a minimum of five years with renewals. Giving the landlord some certainty may encourage amenability to deals."
Here are some additional tactics:
- Find an alternative location. Get a better seat at the negotiating table by having a fallback space if your landlord balks at a deal. You can say something like this: "Look, we have a brand-new deal at a new location, where those guys will pay for us to be there. Or we can do a deal with you at this new number."
- Consider a "blend and extend." If you have two years left of a five year lease try getting some immediate rent relief — in terms of free months of rent or a lower monthly rate — in exchange for signing a new five year lease, provided you feel assured of your ability to fulfill a long-term contract.
- Watch your annual increases. An annual rise of three percent seems to be the industry standard around the country. A landlord might ask for a four percent increase in exchange for funding some improvements in your space.
- Negotiate rent escalations. If you sign a three year lease it comes with an increase each year. Prolong when it takes effect. Maybe delay the rent escalation for two or three years, and put a cap on them. If the lease says the increase will be based on "fair market value," that may be higher than you expect if vacancies decline in your market.
- Make sure your lease includes a "first right of refusal" clause. This gives you the right to decline a renewal before the landlord offers the space to someone else.
- Obtain termination powers. Try to get an agreement where either party can terminate the lease with 90 days notice. Landlords don't like it but in this market it's easier to negotiate exit strategies.
- Obtain right to sublease. One way to cushion your rental expense is to sublease part of your space to another retailer. However, this has to be negotiated up front. Some leases prohibit the practice.
Your negotiating success will depend partly on the quality of the neighborhood where you operate your store. "Landlords are well aware of the value of the best AAA sites," says Parkinson. "While some of these landlords will offer incentives these rents are not very negotiable."
And other sites? That's a different story. "Landlords in secondary retailing areas such as some neighborhood strip shopping centers and central business districts are susceptible to tenant negotiations," says Parkinson. "Possibilities may include a reduced rate for square footage, a cash contribution to fitout [redesign] space or a rent free period or a combination of all of these."
Filling Space
As mentioned earlier, the window for better deals seems to be gradually closing. Given the rebound in the economy, analysts at Grubb & Ellis believe that retail vacancy rates have pretty much bottomed out. Indeed, some markets have seen a vacancy rate decline.
"The deals are still there for tenants, particularly as you move down the quality spectrum," says Bach. "But for the better properties — well located, strong trade areas, not a lot of competition — landlords can afford to be a little choosier than they were a year ago. This is particularly true for centers occupied by upscale retailers, who enjoyed very strong holiday sales thanks to the booming stock market."
Also, the economic rebound has given landlords a little more psychological edge. Landlords who are less nervous about the future than they were a year ago will be less prone to deal. "Any given set of market conditions looks different on the way up versus the way down," says Bach.
In recent months landlords have become more restrained when allowing lease modifications. They want to make sure that retailers are strong enough to continue in business even after the terms are changed. "More landlords are asking to see financial statements before lowering rent," says Fried. "They figure the retailer who is really broke is not worth retaining anyhow. So there is not as much room to maneuver as a year ago."
Have a strategic plan. Landlords will ask "what will you differently?" Show how you can do a better marketing job with the money you save with the rent.
As these comments suggest, it's wise to go into negotiations armed with data on your operations and on rental rates for properties near your location. "In all cases a healthy discussion with your landlord will usually produce results," says Parkinson. "Remember that there can be no successful negotiation without compromise from both parties. The level of compromise is directly related to the amount of concession sought."
