Friday, April 13, 2018

Retaining "Mom-and-Pops" in the New Retail Reality

Dan McCombie is a research associate at Larisa Ortiz Associates

Lots of rumblings lately about the statement New York Mayor Bill de Blasio made on local radio WNYC, wherein he spoke about his receptiveness to a commercial vacancy tax to address rising vacancy rates in the city. The issue is decisive to say the least. Certainly we don’t need to go into detail about all the reasons why retail vacancies are problematic (apologies if you’re new to CDA). Nor should we fail to recognize that using public policy to regulate private property is nothing short of a perennial third-rail. What’s the right move?

My purpose in this blog post is not to wade into the vacancy tax debate. It's a complicated issue. Yes, vacancies are problematic and in many instances can create a chain reaction to eventual blight. But policy prescriptives, even with the best intentions, can also be clumsy tools. You want to save mom-n-pops so you tax the vacant space. But if the landlord decides to swallow the cost, or brings in a Verizon Store instead, what did you really solve for?

Photo: essygie

For me, the interesting part of this debate is in understanding how developers and property owners are exploring how to tenant retail spaces with local and regional independents instead of nationals. Why? Because these classes of tenants are typically less "credit-worthy" than your Bank of Americas, Verizons, and Dunkin Donuts, and therefore carry more risk for investors and owners. But they also  have the capacity to bring much more in the way of unique character to a commercial district. So what can be done to mitigate against the credit risk? I found the following example telling...

The Market Line – Lower East Side, MH

The following statement came from Essex Crossing marketing material and can also be found on the Market Line website:

“Anchored by the new Essex Street Market, The Market Line will extend three full blocks from Essex Street to Clinton Street. With over 100 vendors and 150,000 sf of gross floor area, The Market Line will be one of the largest markets in the world, reminiscent of iconic locales like Boqueria, Borough Market, the Grand Bazaar, and Pike Place Market. While there will be an unparalleled collection of prepared foods, this will not be a food hall, but a market. The Market Line will be a microcosm of the Lower East Side with an eclectic mix of local food purveyors, artists, gallerists, musicians, and designers…” (emphasis added)
The emphasis on the local independent tenant mix is worth noting. The other day I spoke with an individual with some knowledge regarding the tenanting strategy for the Market Line, and I posited the question: “How does one tenant a space with local and regional operators when many investors perceive them as carrying more risk?” The response was fairly simple:
  1. Provide smaller floor plates with shorter-term leases
  2. Partner with architects/designers to create and curate attractive turnkey spaces
  3. Seek out tenants with a proven record of success

Again, none of this feels surprising. But it helps to contextualize these tenanting strategies within larger trends. Retailers across the board are right-sizing into smaller spaces, which may be more costly on a PSF basis, but cheaper on the whole. And a whole new industry is sprouting up around the design, buildout, and brokering of flexible pop-up spaces. The Market Line seems to demonstrate how these play out at the ground level. Yes, having a short term lease may be untenable for many, but the property owner can certainly mitigate against this by providing more upfront support through tenant improvements so the merchant doesn't feel like their throwing their money away on the build out. To understand this further let me present two more cases...

Photo Credit: The Market Line

Williamsburg, BK

Consider the case of the impending L-Train subway shutdown and the Williamsburg neighborhood in Brooklyn. Fears are that without a direct link to Manhattan, merchant performance is going to take a hit during track work, and so many of them have left or attempted to negotiate lower rents. Rather than bring down rents to offset the hit, some landlords have opted instead to weather the storm until the work finishes, believing an empty storefront is preferable to signing a long-term lease with a myopic rent. As a result, the retail vacancy rate in the neighborhood was recently reported to be at 13%, which is definitely cause for concern. Are the property owners right to hold tight until business as usual returns? Next example...

The Shay – Washington, DC

A relatively new mixed-use retail development in the Shaw neighborhood of DC, “The Shay,” has also been struggling with retaining retailers. The primary reason for this is that the tenanting strategy from the outset was admittedly a risky one. Jay Klug, executive vice president of retail at JBG Smith (the developer), confirms that instead of focusing on restaurants and national chains (low-risk) they would seek smaller stylish brands looking to expand into the DC market. In order to entice these tenants, the developer negotiated percentage rent agreements. Steve Gaudio, VP at JBG is quoted as saying “There was a risk that their percent of sale would never be that high, so there were different flexibilities for both the landlord and the tenant to determine, if this didn’t work out, that they could walk away.” As might be expected, many tenants didn’t hit their marks and did walk away. But notably, many of those tenants were soft-goods brands like Kit and Ace and Steven Alan, and were subsequently replaced by businesses like “The Shop” hair salon and “Turning Natural” smoothies shop. This is not to imply that soft-goods and apparel/accessories can’t survive; the Shay also houses the first DC location of Warby Parker and the fourth Bonobos location in the region, both of which have been said to be performing at a high level. What it says to me is this development may want more high-end neighborhood-serving uses and less comparison goods. In any event, the mix needed to be tweaked a bit, especially for a new concept still establishing an identity.

Photo Credit: The Shay

The Takeaway

The Market Line tenanting strategy has flexibility built into both the lease and the space itself so that if a tenant isn’t working out, the arrangement can be modified expediently. The Shay, adopting a similar tenanting strategy, uses a different mechanism with percentage rent agreements. In Williamsburg, some owners are simply holding their breath. Are any of these success stories? Hard to say. The Market Line hasn’t opened yet, and The Shay is still struggling with vacancies. Both are big (150K SF and 120K SF, respectively) and have the benefit of a single entity curating the space, and lots of design muscle behind them to make the spaces attractive to tenants. And even Williamsburg is a bit of a snowflake; it's an iconic neighborhood so it may be able to hold on after all. For that reason, I caution against making too hard and fast a conclusion. But the one thing that seems to have unanimous consent these days is that retail has changed, and likely changed irrevocably. As a result, we need to be creative with how we tenant spaces and not be afraid to tweak not only the mix, but the way spaces are constructed and agreements are negotiated. And there’s no way to know what works when the space is empty. 

Thanks for reading!

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