Tenants and landlords speak out in Strolling the Agora on the advantages and disadvantages of this leasing concept in the April 19th, 2010 issue of the twice-monthly newsletter, SHOPPING CENTER DIGEST.
While discussing overages with a developer of a new regional mall in the New York Metro area some years ago, I remember clearly his attitude and comment: “If a tenant goes into overages,” he said, “it means the rent was too low.”
That company has been out of business for two decades, and the dealmaker quoted has also become only a memory in the shopping center/retail chain industry.
And in today's market, that “take it or leave it” attitude has also disappeared from this industry.
To many, overages – where a lease is based on a low minimum rent tied to a retail sales figure, and the landlord shares in the upside of sales over that figure – had been a mainstay of this industry, primarily in malls; tenant and landlord, in essence, became “partners” and participated in the risk of opening stores in new and unproved shopping centers, or was used as an inducement to attract retailers to lagging projects.
Peter Morris, CEO of Greenstead Group, noted that this was a form of percentage rent which is “actually the cheapest form of rent.”… “Over the years, however, both sides of the table changed the concept to eliminate sales rent and build it into the base rent. That was great for the tenant in an expanding market as it fixed their costs. However, as sales have decreased tenants are seeking concessions in order to bring down their cost of occupancy.”
There are two main areas for sales rent to return on a wider basis, he continued. These are “tied to rent relief to accelerate the recapture of the deferred rent” and “as part of a creative rent structure to spur on leasing. Think of it as deferred rent at the onset of the lease.”
Good Source Of Profit
“Overage,” said Karen Scott, president at Centerworks Retail, “can be a good source of additional profit but the Landlord has to be very good at assisting tenants in making the break even points through effective marketing programs. Also, when marketing, don't spend time on the underperformers which is what people tend to do; instead concentrate on the ones who look like they can make the break even and help push them over. So if you are going to do this (and basically partner with your tenants) hire an experienced marketing person… .and require a minimum amount of participation in marketing programs-yes, for those of you [who] have been around awhile, this is beginning to sound familiar, right?”
Gail Nichols, vice chair and co-founder of The Now Mall, took off on the subject of marketing and pointed to national averages for mall sales tied to consumer purchases, and said that the impact of full multi-channel marketing using Rapid Online Order Fulfillment (ROOF) could “bring back lost sales and generate new traffic into the mall… not to mention happier customers.” She said the internet is “stealing away mall sales at the rate of 12% now, but growing rapidly to 35%-53% in 2014… ”
A national retailer stressed that “just because sales have jumped in a specific store, does not mean that profits have matched that rise. More sales does not necessarily mean more profit. In the current economy, retailers have drastically discounted their merchandise to boost sales and move inventory. Though a reduced rent can be an inducement to make a deal, providing the landlord with a piece of this upside of store sales can eliminate much of the profit.”
One leading consultant was not a strong advocate of this form of leasing. “A major concern for an owner-developer is to audit their tenant's books to determine a true 'overage.' Most landlords would rather give away more concessions than play a forensic accountant.”
The whole issue, according to Jeff Davenport, principal of Davenport Consulting, gets into base points. “It depends on the level of overage rent a tenant will be paying. Are they paying 8% or 18% over a breakpoint? What is the breakpoint and how was it derived?… Yes, the low base rent/overage rent concept should help attract new tenants
because it shifts risk from the tenant to the landlord. Of course, this assumes reasonable overage rent and breakpoint terms are offered by the landlord.”
Another landlord stressed the importance of negotiating fair and reasonable terms.
Rohit Bakshi, CEO of CCPL Developers Pvt Ltd, “As a center head, in order to fill vacant space at non prime areas, even taking up brands on franchise mode is also lucrative. I strongly feel that any investor should look into the possibility of fixing a minimum guarantee amount and percentage share, this way the risk is being shared between the retailer and the investor.”
Chuck Devers, owner, SOM, LLC, said overage contracts “can be very useful tools in helping a prospective future tenant, or even an existing tenant to take responsible business risks to either up-grade, enlarge or otherwise improve the selling environment… “
He cited an example of one tenant who was at the crossroads, continue doing what he had been successful at, or “implement a new marketing concept that would require a total re-build [and] introduce a new product line in an enlarged store… We joined together as landlord and tenant and negotiated a new lease that controlled rent increase to a very modest level while increasing their selling space by 50%.”
The results, said Devers, were “spectacular for both of us… ” Sales increased more than 50%, lease income increased over 50%, and the store's profitability increased greatly in excess of 50%. “The concept worked so well, in fact, that the company determined to replicate the model on close to 800 of their existing retail clothing stores.”
Caution should be taken in the use of overage deals, cautioned Morris. The landlord's come-on rent structure needs to be short term and carefully planned. The landlord “may get some more deals done… [but] as my father used to tell me it is false economy to make each sale at a loss but expect to make it up in volume.”
Further information on Shopping
Center Digest, our weekly Eflash, Expanding Retailers,
and the annual Directory of Major Malls may
be obtained from our website, www.shoppingcenters.com.
Strolling the Agora was a twice-monthly column discussing trends, issues of importance, and commentary on the leasing/development aspects of the shopping center/retail chain industry in the US and Canada. Called Strolling the Agora, it was a part of Shopping Center Digest, a newsletter founded in 1973 published until September 2010. The column provided expert insight into various retail focused topics. It was primarily authored by Murray Shor, Editor & Publisher as well as industry and veteran retail experts. A smattering of archived columns are presented here for your reading “pleasure”. It's an interesting “look back” at what were current hot topics at the time with regard to shopping center/retail industry focus, development and leasing expansions and processes, retail mix, opinions and more.
About Murray Shor:
Reporting and writing on the shopping center/retail industry since the late ’60s. Began as editor at Chain Store Age, founded Shopping Center World (now Retail Traffic), Shopping Center Digest “The Locations Newsletter” in 1973, and the Directory of Major Malls in 1979. Each issue of Shopping Center Digest contained a column called Strolling the Agora which provides commentary on trends, activity, issues of concern to development and leasing in the shopping center/retail industry.