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!

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!

Related blog posts:  
The Original Food Hall
Here's What to Expect in 2018 and Beyond
When Skyrocketing Rents Don't Always Mean the Death of Small Business

Whole Foods + Daybreaker = Experiential Grocery

Dan McCombie is a Research Associate at Larisa Ortiz Associates

**The following blog post contains a brief discussion of the state of online grocery retail, and then turns to look at an experiential company (Daybreaker) that has partnered with a grocery chain (Whole Foods) in what is a unique example of experience-based retail. At root is an exploration about how we understand customers, what they want to see in today's brick-and-mortars, and how "experiential" can have a broad range of applications.**

Here we are now, almost a year out since Amazon officially announced its acquisition of Whole Foods Market, the chain known for its high-quality, natural, and organic grocery store model. This $13.7BN deal fueled speculation that the e-commerce giant was making a play for a larger share of the online grocery retail market, and could feasibly change the entire way we think about food access. Sure enough, we have seen some marked changes in the way Whole Foods functions, but has the trajectory of online grocery retail changed all that much?

Some insight can be gleaned from a recent article by Neil Stern, a contributing writer for Forbes, wherein he summarizes Forrester's "The State of Global Online Retail 2018" report. Here are some of the key findings from it:

• The global online grocery market is predicted to double from $150BN in 2017 to $334BN by 2022
• The online grocery market is still wide open "as retailers race to become the default provider"
• Countries differ in their adoption of online grocery based on factors like geography and economic maturity

To this last bullet point, Stern further explains that geographically concentrated (denser) markets are further ahead in their embrace of online grocery, primarily because their distribution systems are advantaged through economies of scale. They don't need nearly as much infrastructure to serve the same amount of people, whether that's based on home delivery (e.g. Fresh Direct, Peapod) or a click and collect pickup model.

So does this mean that urban markets might start to see brick and mortar grocery lose ground faster than less-urbanized markets? Possibly. If that is the case, it feels like an important one. Grocery stores help support a host of smaller neighborhood services and stores. In short, they're both commercial catalysts and anchors. So any trend in the markets that impact their health is liable to have huge ripple effects. To be completely honest, I find it highly unlikely that Kroger and Publix (shout out to my friends down south) are going to disappear overnight. Nor do I think they'll all turn into Amazon fulfillment centers (or maybe they will). In any event, this got me to thinking about ways grocery stores can adapt. And if we've learned anything in recent years, for retail its either death in the middle, or death for being boring.

Which brings me to Daybreaker.

For those not familiar, Daybreaker is maybe best understood as a company that organizes and manages large, high energy, highly-attended early morning dance parts with a deep health and wellness focus (read: no drugs, no alcohol, only natural adrenaline). Though not the only company peddling the pre-work experiential dance rave model, they've definitely risen to the top with a presence in more than 20 cities worldwide, including San Diego, DC, Vancouver, Sydney, Mexico City, Berlin, Tel Aviv, Stockholm, etc. 

And I bring them up because on May 10th, 2017, they held one of their dance raves at the Whole Foods flagship location on Lamar Boulevard in Austin, TX (a month prior to the Amazon acquisition, for those who are wondering). The itinerary for the event consisted of a 6am-7am yoga class, followed immediately by a raucous dance party from 7am-9am. Music was provided by both a record-spinning (or is it laptop-clicking?) DJ and a "legendary husband-wife hop hop duo." It really doesn't get less boring/more experiential than that for a grocery store. Did I mention Whole Foods provided breakfast? This all brings me to my next point...

Millennials. 

Daybreaker is perhaps the epitome of a company that is operated by and creates events for young Millennials. If you need further proof, one need only look at the event description (posted here). Give it a quick read and you'll notice the frequent use of emjois, the way "yoga session" becomes "yoga sesh" and "amazing" is spelled "uhmazing." If Gigi Hadid was a language, I think this would be it. 

To drive this home a little more, the following quote was culled from the Daybreaker website:

"DAYBREAKER IS CREATING AN ENTIRELY NEW GENRE OF EXPERIENCE. We are a global movement driven by incredible humans who turn crazy ideas - like sober early morning dance parties - into reality. What began as a social experiment and art project, Daybreaker is fueling a worldwide movement to increase mindfulness, camaraderie, wellness, self-expression, and mischief."  

Mindfulness. Camaraderie. Wellness. Self-expression. Mischief. These are the Daybreaker core values. And personally, I think these serve as a great shorthand way to describe the Millennial shopper (depending on how you slice the age brackets). Some might quibble with that statement for reading as reductive, especially the Daybreaker apparatus itself, but often times that's an inherent challenge to understanding any customer demographic. We always prefer to collect primary data when possible, whether through first-person testimonials, surveys, focus groups, etc, but comprehensive big picture analysis also requires we look at things like U.S. Census and Bureau of Labor Statistics data, secondary syndicated sources, and other aggregated information that necessarily obscures individual nuance.

To summarize, if you feel like you don't understand how Millennials shop, perhaps this is a good template. I don't have figures for direct economic impacts of the Daybreaker event, but without a doubt it created strong associations between an established retailer and an exciting experiential brand. Nor was this the first time Daybreaker had collaborated with a large retail brand, having also partnered with Saks, Nike, IBM, Samsung, Macy's, GE Electric, Clinique, etc.  It also raises an interesting paradox when you go back to Forrester report: dense urban centers where brick and mortars may be more imperiled by online retail is precisely where young Millennials concentrate, and thus where it makes more sense to explore experiential marketing opportunities.

Key takeaways:

• The Amazon acquisition has not impacted brick and mortar grocery the way many anticipated
• Regardless, online grocery is a growing share of the overall market
• With that in mind, retailers still need to think about how to differentiate themselves and not be boring
• That means understanding your customers and what gets them up in the morning (in this case kombucha and a dance party)

For those who were good enough to make it this far in the post, I definitely recommend revisiting a past post on this blog by Mike Berne of MJB Consulting, written in the days following the announcement of the Amazon acquisition of Whole Foods. One of Mike's main points is that Amazon's motivation for the deal was driven not so much as a way to "conquer the grocery space," but rather to gain valuable real estate in close proximity to their predominantly urban Amazon Prime customers.

Thanks for reading!

Instagram post from the Daybreaker Austin launch
Image: @dybrkr

Instagram post from an event at the National Building Museum, DC
Image: @dybrkr

Shipping Container Pop-ups: Best Practice or Best Forgotten?

Dan McCombie is a Research Associate at Larisa Ortiz Associates

I caught myself typing this into my google machine the other day:

“Are shipping containers still cool?”

This question has been on my mind as of late, given that the phenomenon of turning shipping containers into pop-ups for retail, exhibition space, offices, and even tiny homes, has been going on for quite some time now. Many people are no doubt familiar with the well renowned downtown Container Park in Las Vegas, constructed in 2013 as part of a huge reinvestment package spurred by the relocation of online retailer Zappos to the neighborhood. And I personally remember when back in 2011 my hometown of Christchurch (NZ) had its central city devastated by earthquake, spurring the city to create Re:Start to quickly breathe life back into the CBD. Are people still doing this? Is it still perceived as both a savvy marketing scheme and opportunity to catalyze revitalization? Or is the public starting to experience container-fatigue?

What’s the problem with containers?

Admittedly, there is a part of me that sometimes looks upon containers with disdain simply because they are so ubiquitous now. But I stumbled upon this quote from an article by John King in an article he wrote for SFGATE.com, wherein he waxes on the creation of “Proxy,” another container park constructed in 2011 in the Hayes Valley neighborhood of San Francisco:

“This isn’t about architecture so much as urban place making: you’re less aware of the structures than of the surroundings. The containers aren’t treated as sculptural elements, as is the case recently in other international cities. They’re content to add layers to the landscape, enlarging the Hayes Valley experience without making a fuss.”

Which I interpret to mean: “Calm down. Forget about the medium and consider the effect.”

And rightly so. I actually visited Proxy when I was last in San Francisco, when a couple of friends brought me to the beer garden there (Biergarten). Recalling that visit and doing some background research, I learned that Proxy was exactly as the name describes—a temporary placeholder until more permanent development could take place, much like Re:Start in Christchurch. The site on Octavia Street was originally an underutilized parking lot that the city sought to redevelop for affordable housing. However, the original plan was tabled with the advent of the economic recession. Rather than let the site lay vacant and an eyesore on the neighborhood, the city and the Mayor’s office bid the site out for a temporary and less costly installation, to which the designer/developer/operator Envelope A+D responded with their plan for a “flexible environment of food, art, culture, and retail within renovated shipping containers.” 

Although city codes lacked precedent for a “temporary” retail operation lasting more than 90 days (the project is due to expire in 2020), stakeholders were able to negotiate an agreement such that project became a reality. Now retail tenants include a mix of established brands and start-ups taking their first incremental step towards brick and mortars. In addition to retail offerings, the project hosts film screenings, art installations, and serves as a performance/event space creating a bonafide neighborhood gathering place.   

What have container parks like Proxy meant for retail?

Proxy bucks the trend in retail in the sense that in spite of its positive public reception and the relative success of its tenants, it plans to shutter in a couple of years. Why remove something that seems to be a success? Because it was always designed to be a stop-gap and of course the need to grow the supply of affordable housing in the Bay Area is still an acute need. But the lessons remain. What Proxy did well was create density in a vacant space. It was consciously conceived as a means to revitalize a previously blighted area, a parking lot that had also been the former site of a freeway. There were other things Proxy did well—curating the mix of tenants in a meaningful way and targeting operators that could feasibly make the jump to brick and mortars after a period of incubation. I also appreciate that the designers consciously eschewed the term “pop-up.” In a quote from Douglas Burnham, founder of Envelope A+D:

“We specifically don’t use the word ‘pop-up’ because it doesn’t really mean anything to us anymore…We think that a thoughtful insertion of compelling temporary uses can be an effective strategy to bring vibrancy to languishing parts of the city. There’s nothing trendy or faddish about this.”

Admittedly, one could argue it is a bit faddish to treat “pop-up” as a pejorative term. But I think this gets back to my main takeaway. Before you critique something for its popularity, it’s important to consider if and why it actually has staying power.

So…do containers have staying power?

As far as I’ve been able to tell, the containerization of our lives continues unabated. Large brands like Budlight, DSW, Puma, HBO, and HP are increasingly demanding container pop-ups for experiential retailing strategies while a growing number of companies are supplying both specialized and turnkey options. They range from Co-Working in a Box’s “PopBox”, Britten’s “BoxPop”, and Vacant’s mobile container truck, each providing a range of design and consultative services to help get businesses off the ground and engage customers in places they didn’t expect.

And let’s not miss the fact that a whole segment of companies have an identical model for indoor pop-ups. The shopping mall giant Macerich’s Pop-Up EXP program provides 100-300 SF of space with micro leases, and modular components. The difference here is we’re not talking about containers. Again—this suggests a larger trend with momentum and that the medium (containers) is really beside the point.

What’s on the horizon?

Some forward-thinking folks have gone so far as to envision containers as outparcels–parking lot satellites to larger retailers located inside shopping malls. For example, perhaps a Nordstrom anchoring a mall uses a container in the parking lot as a small fulfillment center so customers have the convenience of picking up their order on the fly without the full commitment of going inside. It’s no stretch of the imagination given the way e-commerce has pushed the industry towards more rapid and flexible retail with just-in-time delivery schedules. And what with autonomous vehicles ahead, these trends will surely continue into the foreseeable future.

Personally, I’m excited to see pop-ups and container villages keep building off of what has worked in the past. Invest Atlanta, the City of Atlanta’s Development Authority, approved $550K in funding to create an “MLK Innovation Village” built out of shipping containers in an empty parking lot adjacent to the H.E. Holmes MARTA station. The village will include an outdoor gathering space, retail, and at least nine offices with the intent that this “semi-temporary” project will be a catalyst for future transit oriented development in the area. It’s the same model as Proxy and Re:Start, but with a creative transit component that could give it possibly massive multiplier effects.

Which is all to say, I think we still have a lot of containers coming our way in the future.

And that’s quite alright with me.

Puma City
 Multiple Global Ports

Re:Start
Christchurch, NZ

Proxy
Hayes Valley neighborhood of SF

Container Park
Downtown Las Vegas