How landlords, brokers and lawyers can help retailers stay alive.
Despite the hyperbolic headline-grabbing hysteria ringing the death knell of stores, the retail industry is very much alive. For as long as mankind breathes, we will need supplies. Humans are hardwired to shop. Consumerism, as examined through the periscope of history, is really just an elevated form of our pre-civilization survival skills of hunting and gathering. We collect, we acquire, we devour, we display.
Understanding how we shop today requires reflecting on how we have shopped during other times in history; Only then can we begin to properly envision the shopping of tomorrow. In this context, it becomes clear that mankind will forever shop — shop until we drop, in this literal sense of the word. Rather than contributing to the free fall of retail and helping perpetuate those misconceptions, perhaps we should pause and examine the evolution of retail to help preserve its future viability.
IN THE BEGINNING
Contrary to what an alien landing on our planet today might think, shopping centers are not part of the earth’s crust. They grew over time. Historically, retail was limited to a set physical location. Ever been to Pompeii? Or the archeological Roman bazaar ruins in Jerusalem? There you see gathering and bartering places where our ancestors exchanged stories and goods. We left our homes — be they caves or rudimentary huts at the time — to meet up with others: to find love, source food, gain knowledge, and trade goods. For thousands of years, long before the modern mall was manufactured or credit cards invented, and eons before currency was systematized or transportation efficiencies made the entire world accessible, we walked and rode camels and found what we needed and exchanged what we had for what we desired. And all of our transactions occurred at a specific physical place.
Out-of-store retail was first introduced with catalog sales in the late 1800s when Sears, Roebuck and Company issued its inaugural catalog. And for the next 100 years, retail was transacted either at a specific store or through a catalog sale, with an order placed by mail, or later by telephone. In the early 1990s, with the advent of safe encryption of credit card numbers, early experimental online sales began to take root. The launch of Amazon.com in 1994 completed the stage for the dramatic revolution that has drastically changed — and continues to change — the way we shop today. And shopping went from being place-driven to space-driven: We can now shop anywhere and everywhere.
E-COMMERCE, NOW AND THEN
As e-commerce took on life, the retail real estate, legal and brokerage communities were initially concerned with how this would impact existing business models. With rent valuations traditionally based on sales origination, and calculation of gross sales and percentage rents to landlords, how would online sales change this structure? Early confusion quickly quieted down: The volume of online transactions was not enough to be transformative. E-commerce was somewhat limited to books and music, and other tangible goods, that were easily acquired at a desktop computer. The traditional shopping patterns stuck, with online just another venue to purchase certain categories of goods.
Until those patterns didn’t stick anymore. The confluence of a drastic recession, and a rising young, technologically savvy demographic all combined to significantly modify shopping behavior.
First, the creation of the iPhone in 2007 was the catalyst for rapidly advancing mobile technology, and it quickly opened channels for smarter, faster, targeted, and interactive e-tail. Then, the global economic meltdown resulted in the shuttering of thousands of stores, and the reshaped environment became populated by stronger retailers who used the recession to curate their brands. Thirdly, the emergence of the millennial class (roughly defined then 18 to 35-year-olds) translated to a preference for digital shopping for the instant-gratification generation. The smartphone also aided them with comparing pricing instantly during struggling economic times. Constituting approximately 25 percent of the U.S. population, this powerful segment has demonstrated that we can shop with our fingers rather than our feet.
Clearly, same store sales — the traditional barometer by which Wall Street measures retailers’ successes — continue to experience muted growth across all channels. Even luxury players, who were responsible for much of the success of urban retail during the period from 2010 through 2015, have been experiencing setbacks during the past few years. Their struggles have been the result of international exchange rates favoring the U.S. dollar, stratospheric real estate valuations in New York City and other high-street gateway marketplaces, and more cautious spending behavior among consumers of all classes.
As online shopping grows, both the size and the sheer number of retail real estate brick-and-mortar establishments will continue to contract. The retailer positioned to survive and thrive is one who embraces the new omni-channel universe.
THE HUMAN TOUCH OF IN-STORE
For some retailers, the best use of brick-and-mortar space is as a showroom: a space to see, touch, and try products and services. The store may also be a space to return goods ordered on an iPad on the couch and delivered by FedEx that the consumer can’t bear to rebox. It can give the retailer the old fashioned chance to capture the customer’s fancy and transact a serendipitous sale. Savvy retailers know that no merchandise, no matter how spectacularly displayed, can be truly Amazon-proofed. Yet, certain classifications require a store setting — a computer can never hand you a glass of wine — and our technology does not yet allow a prospective purchaser to feel the soft fibers of cashmere through a screen. What has emerged is the world of omni-channel, where the silos of bricks and clicks sit not side by side, but integrated as an organic whole.
The interplay between internet and storefront sales, when properly crafted, creates a synergy that results in a sum greater than its separate parts. A synthesized understanding of the offline and online customer delivers a seamless layered multi-channel experience that reinforces loyalty and motivates the consumer to shop. Great brands have figured this out and are working very hard to produce an accessible and compelling shopping experience that anticipates our needs and whims as a consuming public. An excellent merchant must do much more than curate goods to display; he or she must now also deliver them into the palms of our hands wherever we may be.
Retail is not dead, it has been reshuffled and reorganized. So, why the meltdown of stores and proliferation of “for rent” signs? Because the landlords and lawyers and dealmakers are not keeping up with the changes.
VACANCY THREATENS YOUNG BRANDS
Brands collapsing because consumers’ tastes are changing is hardly new; it is how the world evolves. But today, the owners, investors and managers of the next generation of retail tenants are no longer willing to be handcuffed to leases with unsustainable economics. The rent barrier to entry in many markets is insurmountable. Retailers are opting to stay local instead of growing their brand or they are limiting themselves to e-commerce instead of following the Warby Parker or Bonobos omni-channel models simply because the rent numbers threaten to kill their start-ups. One international brand, with thousands of stores across the globe, has just shelved its planned rollout in the U.S., unnerved by the failures and resulting storefront vacancies. The solution to the problem thus disappears in this vicious cycle: the potential future occupants can’t make these numbers work either. Retail real estate values have gone down: the store is no longer the entire source of sales, so its value has been diminished. Amazon is not erasing traditional retail, suffocating lease economics is the true culprit.
The families and corporations who control our nation’s retail space need to work with their partners, bankers and investors to reshape the rents that are poisoning our retail future. Fifty cents on the dollar might sound low today, but it is fifty cents more than zero. Landlords are holding the golden goose in their hands: fantastic properties across our country, on small main streets and dazzling high streets, in lifestyle centers and luxury malls, in enclosed and open spaces around the country, but they are perched to kill the goose eggs because they want more gold than they can access. Landlords need to confront and accept this new reality. Economics 101 instructs that, at some point, the intersection of supply and demand is met and then the right number of loaves are baked and all people have bread to buy. What is happening in the retail real estate universe today is that the supply line hovers in the stratosphere, dangerously far from the demand line, and the retailers’ engines can’t reach there safely. Many landlords are literally living in outer space: outside of the realm of possibility where the deals can be made and kept.
MEETING IN THE MIDDLE
The lawyers can help, too: We need bipartisan attorneys to bridge the gap between landlords’ expectations and tenants’ needs. How many panels can we listen to where each side sticks to its script that the other side no longer hears? This playbook needs to be tossed out with the large metal cash registers and non-recyclable bags. Why should a landlord, no matter how wonderful the real estate location that is being offered, be entitled to collect a percentage of the sales that are transacted on your phone, in your home, in a café or anywhere because it happens to be in the same zip code as a particular bricks-and-mortar location?
Rent should not be a complicated algorithm. Office rent is calculated by the value of what that parcel is worth, regardless of who shows up at work or what is accomplished in that space. Retailers should be entitled to do the same. Why should the corporate decisions differ for Unilever or Uniqlo? Shouldn’t a business decide where to have physical stores in the same way it decides where to lease its regional and local offices — in a way that maximizes overall revenue and creates value for the brand by building its customer base and maximizing sales? It should not matter if the strollers walking into a particular door are there to browse or return or buy anew; if the pulse of the store is alive, it will generate heat. And if it does not, store management won’t keep it in its portfolio. Why abort its potential for arbitrary rent reasons that once made sense but should no longer apply?
Retail CFOs and general counsels are distracted trying to resolve when a sale is recognized, where the revenue is recorded, determining the best return policies and procedures and deciding who gets credit for the sale. Why are these even issues? Whether bricks-and-mortar is a store or a showroom should be irrelevant when four-wall profits are no longer the indicator of success, and percentage rent calculations are rendered moot with new business modeling. Lawyers must also be refining the relevancy of operating requirements, radius clauses and other provisions. Our lease documents must address this new reality.
If the landlord and retailer communities come together in their understanding, there is much to be gained. Today’s shopping center should not be showcased in a museum tomorrow. We should keep it relevant and viable. We can do this. We just need to keep the golden goose alive. SCB
— Nina L. Kampler