Vacant Spaces: Blame it on the Bubble?

Dan McCombie is a research associate at Larisa Ortiz Associates

In my last blog post, I briefly discussed how in a down market some building owners choose to hold their retail spaces vacant, holding out until the market rebounds rather than get locked in to an agreement with a lower asking rent. I closed the post by saying that regardless what tool is used to address vacancies (whether that’s through a vacancy tax, a pop-up model, or through some thoughtful rejiggering of lease structure) the important point is that something gets in the space for the overall health of the district. But is this too simplistic? I wanted to dig a bit further. In particular, I wanted to better understand more of the reasons behind vacancies, especially when there are so many ways to temporarily activate the space and earn a rent roll without getting locked into a long-term deal. 

In an article by Konrad Putzier and Marker Maurer, writing for The Real Deal, the authors discuss how lease agreements can be structured in many different ways with varying impacts on rents. They give the example of a 27-story office building at 650 Madison Avenue. Despite soaring property sales citywide, the ground floor retail tenant of this building had a long-term lease with a below market rent. This below market rent held resulted in a lower net operating income, and therefore a lower perceived value for the entire building. If the property owner wasn't looking to sell, it wouldn't be a problem. But in actuality, the owner was looking to take advantage of a strong real estate market. What could they do? 

What they did was renegotiate the terms of their lease such that the retail tenant would pay a higher rent in exchange for cash payments from the owner. With the building showing a higher rent roll, it was able to command a higher value on the open market—eventually selling for a 91 percent premium over the cost of the original acquisition. And the buyer was made fully aware of the arrangement between tenant and landlord regarding the cash payments. 

650 Madison Avenue
Source: Google street view, Oct 2017

Another negotiable concession are tenant improvements (TI). The authors of the article describe a situation where a building owner providing substantial TI is akin to the tenant taking out a low interest loan from the owners instead of seeking outside financing with a less favorable rate. In that regard its win-win. 

The article goes on to state that this practice is not limited to retail. This is something I know to be correct, having shopped for a rental apartment and seen the offers boasting “first month free.” In these lease agreements, the tenant is essentially agreeing to pay the same annual rent, but spaced over 11 larger payments instead of 12. It works well for transient tenants like students or young professionals that don't typically sign for longer than a year, and allows the building owner to show a higher rent roll. 

This all answers to some degree the question why retail rents might be a bit "sticky" and cause vacancy rates to rise, even as news of the retail apocalypse echoes overhead. Lowering retail rent represents a direct hit to the value of a much larger asset. Except the practice can perhaps buoy rents beyond what retailers are willing to pay. Today a growing number of larger retailers are realizing their rents are not pegged to anticipated sales. The following quote from the article sums it up:   

It was in March of 2017 that Urban Outfitters' CEO Richard Hayne first likened the retail environment to the housing bubble, apportioning much of the blame in store closures to eCommerce and the burden of real estate oversupply. Putzier and Maurier differ in that they see a stronger parallel between the inertia of untethered optimism in housing values, and what had been longstanding optimism in retail rents. But there are myriad ways the current retail moment and the housing bubble are different. The housing bubble burst because of the securitization of subprime mortgage debt, not because everybody discovered they could now buy their homes from Jeff Bezos. What I mean to say is we still consume housing in basically the same way as we did before the bubble. But contemporary retail consumptions feels to be a bit more avant garde with more showrooms, less inventory, rapid fulfillment, and everything in between.   

Are we seeing a correction?

In Cushman and Wakefield’s most recent retail market report for Manhattan (Q1 2018), they identified three recent trends:

1. Almost all retail sub-markets posted reduced asking rents due to additional stores coming to market with lower asking rent (the only exception being the Meatpacking District).

2. The SoHo sub-market recorded its eighth consecutive quarter with a drop in asking rents

3. Announcements of new pop-up store openings have slowed down, signaling the trend may be losing some of its steam.

Source: Cushman and Wakefield, Marketbeat Manhattan Retail Q1 2018

Is this a correction? Are we seeing retail rents align with a more realistic market value? Is there a direct correlation between pop-up shop announcements and retail rents? Difficult to say. It does seem to say that property owners are becoming more inured to a condition they thought would be temporary. But an article from The Real Deal out today tells a different story, of rising rents in Brooklyn corridors where new development is taking place. Their narrative is one that says it's mature (and more competitive) markets that have had to adjust their rents while retail pioneers seem to still be doing alright. 

What does this mean for district managers?

It's important to think strategically when approaching vacancies. If you observe a high rate in a district, you might now wonder if it stems from a lack of customer demand, or determine if there is simply a mismatch between asking rents, the tenants who can pay those rents, and if those specific tenants are in demand. Are local property owners institutional investors, or are they longstanding residents with no debt on their property? And of course, there may also simply be an issue with the individual operator, which is a whole other discussion. These are all good and necessary questions to ask oneself. Without asking them we cannot hope to arrive at good and necessary answers for addressing vacant spaces.

Thanks for reading!

HOW TO: Retail in Public Spaces

Nur is an Associate at Larisa Ortiz Associates.

In a previous post I talked about the benefits that parks and retail may stand to gain from being co-tenants. Today, we look at specific ways in which retail has been incorporated into our parks and open spaces. Depending on the size of your public space, you may decide to incorporate permanent retail spaces or temporary, seasonal ones that can easily be taken down to make room for more pedestrians and park users. Either way, these additional retail spaces can be great opportunities for local businesses and entrepreneurs to test new markets, if made convenient and affordable.

Case Study 1: Times Square Plaza

Vendor: Coffeed, a NYC-Based coffee chain

Space: 100SF, in the center of Manhattan's most trafficked area.

Leasing: The Times Square Alliance, the local non-profit BID, designates an area within Times Square for interested vendors who are then required to build their own structures. Electricity, rubbish removal services, as well as security are provided by Times Square Alliance.

Estimated Rent: $20,000/ month with a revenue share of 8% of sales. Times Square Alliance leased the space via Appear [here], an online listing platform that matches temporary, pop-up retail spaces with creative brands and entrepreneurs.

Added benefits to the vendor: Co-branding and promotional opportunities with the BID on its social media platforms and through other initiatives that the Alliance provides to the tourist, business and residential community.

Case Study 2: Astor Place

Photo: The Village Alliance

Vendors: La Newyorkina and Astor Plate, NYC- based businesses that both had existing storefronts in nearby neighborhoods like Greenwich Village and TriBeCa

Space: 110SF (La Newyorkina) and 200SF (Astor Plate)

Photo: The Village Alliance

Leasing: The plaza in which the kiosks currently sit is property of the NYC Department of Transportation (DOT). However, the local Business Improvement District (BID), the Village Alliance, has a contract with DOT to maintain the plaza. Kiosk vendors contract directly with the BID.

The procurement and bidding process of kiosk operators was a long process, according to William Lewis, Marketing and Events Director of the Village Alliance.  The BID wanted to ensure that they were tapping into existing local businesses and building kiosks that were respectful of the surrounding environment and community. Not only did the BID strive to keep local favorite, MUD coffee, being served at the kiosks, the BID also ensured the design of the kiosks were contextual. For example, the kiosk on the south end of the plaza is a metal structure that reflects the style and aesthetic of  the famous Alamo sculpture (the Cube) and the kiosk design of La Newyorkina on the northern end of the plaza features a hand-painted mural that reflects the local neighborhood.

Like in Times Square, selected operators built their own structures but worked closely with the Village Alliance to finalize designs.

Ensuring success: According to Will (Village Alliance), the kiosks are really popular and doing very well a year since their opening. Their success lends itself to creative menus, a variety of products, a strong daytime population, and of course strong connections to the local neighborhood.

The location of the public plaza by new office developments and the Cooper Union School ensures that the kiosks get strong foot traffic throughout the day. In addition, the BID arranges outdoor tables, chairs, and parasols (like in Times Square!) to support the congregation of large groups and encourage outdoor dining in the warmer months.

Case Study 3: Hunters Point South Park

Vendor: LIC Landing by NYC-Based COFFEED features a healthy selection of locally-sourced food offerings, craft beers, fine wines, and specialty coffees and teas. COFFEED is also a charity-minded café known for donating a percentage of its revenue to local charities.

Space: 1,500 SF, at Hunter’s Point South Park, Long Island City’s waterfront recreation destination.

Leasing: The concession spaces was designed and built during the initial development of the park. Bids were later put out for operators by the NYC Parks department.

Case Study 4: Union Square Park

Market: UrbanSpace has operated the Union Square Holiday Market for over two decades

Space: 30,000SF with about 100 vendors, of which 75% are NYC-based. Individual booth sizes range from half-booths (50SF) to double booths (200SF)

Leasing: The market is made possible via a five-year agreement with the Department of Parks and Recreation negotiated with the market’s operator and founder. The Parks Department opens a round of competitive bidding, issuing a detailed request for proposals and site visits for prospective bidders.

Selected market operators then hold open application calls for interested vendors online.

Estimated Rent: Vendor spaces average between $6,000-$18,000 per vendor, depending on location and size of booths. Each year, UrbanSpace has netted around $2.7 million in vendor fees and compensated the City over $1.5 million.

Case Study 5: Downtown Detroit Parks

Market: Winter in Detroit is sponsored by Bedrock and Quicken Loans Family of Companies. Detroit Downtown Partnership collaborates with the nearby property owners to organize the seasonal markets.

Space: 130SF, pre-fabricated glass structures designed by Philadelphia-based Groundswell Design Group

Leasing: The market operators hold open application calls for interested vendors online. Vendors are selected based on unique and creative retail concepts, quality products and packaging, design of booths, and originality of brand

Estimated Rent: $1,000 for the season (inclusive of electrical, lighting, heating, and security) According to reports, the 38 selected businesses generated more than $2 million in sales between November and January.

Regardless of retail model and leasing structure, we must remember not to get carried away with commercializing parks and public plazas whose first objective is to provide spaces of relief from urban living and circulation opportunities. There is always the potential that highly-curated retail experiences with higher price points may indiscreetly exclude a segment of the population that has less disposable income and therefore is less likely to enjoy a costly park retail experience. 

Incorporating free experiences with the retail activities may alleviate such impacts. Last season, at the Union Square Holiday Market in NYC, for example, there were free goodies and interactive photo booths open-to-all. Candy and cups of hot chocolate were distributed for free to all visitors- thanks to sponsorship by Citibank. These goodies were handed out at the sponsor's booth, where free mobile device charging stations and warming stations and lounge seating were also offered - much needed respite from the cold of winter.

As the weather clears up in the coming weeks *fingers crossed*, keep your eyes peeled for the growing trend of retail concepts in your local park and let us know if you think it's a much-needed public space activation strategy!

When skyrocketing rents don't always mean the death of a small business

Larisa Ortiz is founder and principal of Larisa Ortiz Associates.

Broadway between Houston and Canal Streets in
New York is one of the highest rent districts in the City. 

For many New Yorkers, Pearl River Mart was Pier 1 Imports before there was a Pier 1 Imports. The family run Asian-goods department store, founded in 1971, grew over many years until it occupied 30,000 sf on Broadway in Soho. When the lease was up in November of 2016, the landlord increased the rent from $1 million/year to $6 million/year and the family decided to close shop. At the time, the news reported that the "44-year-old store is the latest victim of rising rents on Broadway and increased competition from online retailers like Amazon and Alibaba." A simple explanation for what was likely a much more complex problem.

The old Pearl River Mart at 477 Broadway - among
the most sought after retail addresses in Manhattan, NYC.

So it came as a pleasant surprise to see an article in The Wall Street Journal chronicling the retailer's travails since closing their original Broadway location. It seems they have developed a streamlined formula - a store layout with 3,500 sf instead of 30,000 sf - and a new location four blocks south of their previous location where rents are significantly less. Now the WSJ reports they are expanding to Chelsea Market, a "sprawling urban food hall" in the Meathpacking District - and a "must see" stop along the very popular High Line. Clearly a rent hike wasn't enough to put Pearl River Mart out of business. But they did need to reinvent themselves and find a suitable spot to relocate.

The "new" Pearl River Mart at 395 Broadway,
about four blocks south of its previous location. 

Chelsea Market, soon to be
home to a second Pearl River Mart location.

The lessons here for other businesses - and the city planning officials who support them - are worth noting. It reminds me of what fellow panelist Tony Hernandez, Director of the Ryerson University Centre for the Study of Commercial Activity said last week during our pre-conference session at IDA, "change is not new". This seems like a trite point, but it is one we have to recognize as an enduring truth of retail. He pointed out that since the 1940's, retail concepts have come and gone, and retailers have had to reinvent themselves again and again and again. From the climate-controlled shopping centers that dominated during the 1970's to the Entertainment complexes of the 1980's to the Power Centers of the 1990's, fickle customers and their every changing shopping habits have always been a challenge for retailers. Today's online challenges may be scary, but they fit a trend of innovation and disruptive change that is not without precedent.

What comes next is likely to result in painful change for retailers, but the good news is that retailers like Pearl River Mart have found ways to survive and thrive. The rent hike trend that caused Pearl River to close has also affected other retailers. In early 2016 we completed a market study for the Broadway SOHO BID and projected a market correction that was only then just beginning. In 2015 the Commercial Observer quoted a local broker said "Everybody's asking for too much money. Nobody wants to pay. It's a very overrated market." So it should come as no surprise that the softening the brokers were anticipating then is having an effect now. The same WSJ report that announced the expansion of Pearl River Mart also found that vacancy rates of 23% and asking rents that have fallen 14% to $478/sf.

Yet high rent does not mean lack of opportunity for intrepid business owners. As the Pearl River Mart move suggests, not every street commands the same premium as Broadway between Houston and Canal and businesses should generally search for a better deal in up and coming markets. In fact, the ability to both market and sell on-line means that a high rent location may be as necessary as it once was. In fact, our study found that within the BID area, asking rents of $425/sf were more than double neighborhood asking rents of $195/sf. So moving off the main corridor to lower rent space, and perhaps even shrinking a floorplate, might be a good opportunity, rather than a death sentence. In Perhaps the answer for communities is to support small businesses in their efforts to relocate to lower priced alternatives as a way to help them stay in business for the long haul.

Round Up: APA Awards, Blight Taxation, The Potential of Alleys, Temporary Renters, and Hot Dogs

Great Places in America: People's Choice
Not malls or strip centers, but American's have cast their vote for walkable commercial corridors to shop, district plazas to gather, and authentic neighborhoods to feel community. See the results in this year's APA people's choice.

D.C. Raises Taxes on Blighted Buildings
Blighted buildings plague many corridors and cities. The trend of blight property taxation continues to be a hot topic and a questionable driver of economic development. If it works in one city, can it be modeled in others? We will have to see.

Cities Start to See Potential in Alleys for Commercial Use
I had a great experience in Istanbul at an alleyway bar, which came to show that even overlooked alleys can serve a viable commercial purpose. Cities in the US are beginning to see this potential as well, adding availability and variety to the commercial mix. Learn more about what Downtown Pheonix is doing to activate their alleys. 

Freeman's Restaurant. Image: www.eateryrow.com

Are Commercial Renters Feeling Temporary Like Residents
As urban rents go up an increasing number of residents feel a sense of temporary status in the places they love to live. Are we seeing the same feelings in commercial renters?

Infographic: Charting America’s Hot Dog Obsession
I personally prefer taco trucks but Americans do love their hot dogs. Could commercial corridors benefit from these small purveyors of hot processed meats? They are a testament to pedestrian traffic and business clusters.

Want to know how to make quick friends in the retail industry, and maybe even keep rents reasonable at the same time?

Have you given much thought to what is arguably the most important metric in retail attraction - the sales volumes that retailers can realistically achieve in your district? This data is like the holy grail - everyone is looking for it but very few people know how to find it. Brokers need this information to attract retailers. Retailers need this information to understand what kinds of rent can be supported, and property owners need this information to know what kinds of rents are rooted in reality when setting rental rates. In the commercial real estate industry, the term used to describe and measure a retailer's sales is known as sales per square foot. This "apples to apples" metrics allows us compare and contrast sales figures between markets and retailers. To give you a point of reference, sales productivity in 2015 for non-anchor tenants in U.S. Malls was $474 psf annually. To put this in context, base rent to sales ratio varies from 4-30% depending on the type of business, but for most retailers, base rent should be no more than 5% to 10% of annual gross sales. Assuming a retailer making $474 psf is paying 10% of their sales to rent, their rent would come to $47.40 psf annually. 

Flagship environments are special

It is helpful to keep in mind that in some markets rent has very little to do with how profitable the actual location is. Retailers treat these locations as extensions of their brand, and they will pay what amounts to a marketing fee for what they consider critical brand recognition. For example, along 5th Avenue in New York, one of the world's most coveted retail address, the bag maker Coach recently signed a lease for $4,000 dollars a square foot. That is a big number - a REALLY big number. In fact, not a single publicly traded retailer, with the exception of Apple stores with an estimated $5,626 sales per square foot, sells enough of anything to pay rent levels that high. Not even Tiffany & Co., which is the second most profitable retailer at $2,974 per square foot. But I digress…most districts are not vying for retailers who can pay these kinds of rents. 

The Coach flagship store on 5th Avenue is paying $4,000/sf in rent.
Do you think the sales at this location can support that?
Image Source: Fashionmag.com

What kind of rent is reasonable?

So what kinds of rents are fair game, and how can you tell whether your landlords are asking rents that make sense and will allow a retailer to make a profit?

Let's consider Marshall’s on 125th Street in Harlem, NY. Reported annual sales are $33.9 million dollars spread over 57,000 square feet. This comes to $595/sf in sales. Assuming that Marshall’s is paying between 10% to 15% of sales on rent, their ideal rent would fall in the  $53 to $80 dollar range. When Harlem Center where Marshall's is currently located was signing initial leases in 2002, the landlord was asking between $80-100/sf for the ground floor. Marshall’s, located on an upper floor is undoubtedly paying less, putting the rent in the 10-15% ratio sweet spot.

So where do you find this information?
Well, the good news is that this information can be found for publicly traded companies. InfoUSA is the go to source for sales volume figures. Both ESRI and Claritas use InfoUSA for their business list data. However, private retailers are not obligated to share this information. For most of the districts we work in that means there is no sales data of which to speak. Instead, what both ESRI and Claritas do is model estimated sales figures for these privately owned businesses based on sample business data for millions of other retailers. While is is generally OK, in some cases this ends up giving you clearly inaccurate information. For one high end apparel brand in a flagship district where rents have peaked at $1000/sf we were given an annual sales figure that hovered around $278/sf. Unbelievable and highly unlikely, especially when other similar retailers report selling up to $1,500/sf. But then the algorithm that ESRI uses did not take into account the unique characteristics of this store and its hyper luxury nature. They treated it like any other apparel store and spit out data that wasn’t commensurate with what we know and can determine from what we see.

Overcoming this information gap takes perseverance. It means asking businesses, brokers and property owners what kinds of annual sales their stores are doing. It means keeping a spreadsheet of this primary data alongside the SF of each store and maintaining calculations that keep you informed. This alone will make you and your organization an invaluable resource to your retail real estate partners.