—Article contributed by Albert Stabile and Neill Kelly. Stabile is Vice President Lease Audit, Portfolio Services at CBRE. Kelly is SVP, Practice Leader at CBRE.
The retail industry is undergoing unprecedented change. The long-anticipated industry disruption due to the predicted growth of retail e-commerce has been in the air for years, but the COVID-19 pandemic has accelerated this growth faster than anyone in the industry could have predicted. In the span of less than one year, retailers have forced to soberly reevaluate their brick & mortar strategy with an eye towards optimization. For many, this means finding ways to “do more with less”.
In the Spring of 2020, many retailers went rushing to their landlords in an effort to mitigate the impact of mandated store closures and/or operating restrictions. By most accounts, these discussions were exhausting if not exasperating – for both sides. While these “Round I” (and in some cases, “Round II“) negotiations were a necessary evil for much of the industry, they typically produced little more than a short-term remedy for a longer-term problem.
Beyond the effects of the pandemic, declining foot traffic and softer store-level sales throughout much of the retail industry has brought about a greater emphasis on the optimization of store count, store sizing and overall occupancy costs than ever before. In the background, many retail real estate departments are seeing reduced headcounts through corporate downsizing while being tasked with increasingly larger internal mandates to drive their portfolios towards the future. In other words, to do more with less.
The 5 Pillars of a Successful Occupancy Cost Reduction Program
Have a Realistic Plan.
“Ready, Fire, Aim” is not a plan. The most successful programs require a considerable amount of advance strategy and analysis. We often see retail RE departments confronted with unrealistic savings targets handed down by the C-suite. These mandates are rarely met because they are usually the product of broad-based assumptions that assume “across the board” or “portfolio wide” savings. The development of realistic savings targets must involve a careful store-by-store analysis that takes into account a multitude of factors including lease term aging, relative individual store performance and specific site/market-based factors – just to name a few. Any cost reduction program that ignores this process will run the risk of falling short of the stated goal.
Perfect Your Ask.
Once you have devoted the time to carefully analyze your store fleet, the results of this analysis will provide clues as to how to tailor your ask. No successful program goes to market with a “one size fits all” approach. If portions of your portfolio continue to suffer from COVID-related impacts, then by all means craft your ask around that. For everything else, the ask largely depends on the specifics around each location. High-EBITDA locations logically require less help than marginal or EBITDA-negative locations. The strategic segmentation of your ask(s) will help convince landlords that you have taken the time to do your homework. You never want to appear to be “dialing for dollars”.
Understand Your Leverage.
As is the case with any successful negotiation, you need to be certain that you have either a “carrot” or a “stick” to enhance your chances for success. “Carrots” may consist of lease term enhancements, relaxing of certain co-tenancy clauses or even fair-trades across a portfolio with a common landlord. All are potential positive motivators to induce a landlord to cooperate. Take the time to understand what those items may be in advance of any negotiation. Conversely, a “stick” may include the real threat of closure or relocation or potential co-tenancy or occupancy violations that may be triggered in centers with increasing vacancy rates. In a sober assessment of your pre-negotiation leverage, it is essential to have at least one of these arrows in your quiver or you will struggle to gain your landlords cooperation.
Devote the Proper Amount of Resources.
For a retailer with hundreds of stores and limited internal resources to devote to a robust cost reduction program, proper allocation of resources is critical. Do you have the current number of internal resources to conduct your negotiations or do you need to bolster your team by new hires or outsourcing? How can lease administration support the effort with documents and data? Does your internal legal team have the bandwidth to process a swarm of amendments or do you need outside counsel? Even the best laid plans can be thwarted if not supported by sufficient resources.
Be Mindful of Your Brand.
These programs need not negatively impact your brand. Landlords understand a retailer’s responsibility to contain or reduce operating costs. They also understand the implied partnership between landlord and tenant. Both parties want to succeed. A “scorched earth” approach towards these negotiations is unlikely to produce a better result but can have long-lasting negative implications on how the landlord community views a retailer as a tenant.
It’s Not Just About Base Rent
To maximize leverage a full scope audit of all financial consideration transacted should be a component of every occupancy cost reduction effort. The identification of past overcharges offers incremental negotiation leverage against the landlord:
- Audit windows, binding statement provisions and statutes of limitation are no longer typical constraints in establishing a claim that will be used to offset something of greater value to the retailer.
- Landlord’s will be concerned that if a settlement is not reached that a lawsuit will be public knowledge along with the landlord’s accounting practices for its remaining tenants to see.
- Settlement agreements if reached without a full scope audit may unnecessarily leave valuable dollars on the table if mutual releases are in play.
- Identified overcharges and questionable landlord accounting practices that are contrary to the lease provisions can be specifically addressed in any settlement agreement to further promote cost avoidance of these charges in the future.
Final Thoughts
As retail tenants begin to adjust to the new paradigm, many will take a fresh look at how they manage their store base in the years to come. Efficiency, cost, and optionality will drive real estate decisions going forward. If the last year has taught us nothing else, it has taught us that change can come quickly – sometimes overnight. Retail landlords know this as well and will eventually adapt to this change. Always be mindful of their struggles. Although it sometimes may not feel like it to those who have endured a seemingly endless series of store-by-store battles, the adversarial nature of the industry’s COVID-related conflicts will be forgotten and both sides will begin to move forward in a more mutually beneficial partnership.