Zero-Based Thinking And Our Leases

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Recently, a 7- year old asked us a couple of questions. The first was: “How old will you have to be to drive a self-driving car?” The second was: “Will you need a driver’s license.” Our immediate, gut thought was that one won’t really “drive” such a car. You’d be a passenger. We’re not thinking about transitional vehicles; we’re thinking about fully-functional ones without driver controls. Then, upon reflection, all of this taking place before we uttered a response, we “knew” that states will set a “driving” age and require a license. Even after we get to control-less vehicles, those requirements, already in place, will exist for at least many years.

If we started from scratch, so to speak, we’d think about the age at which children should be left alone, not whether they are on a bus, on a train, flying alone or in a self-driving car. We’d think about “why” we require driving licenses. But, that’s not how it works. When the reason for a law no longer exists, we often just find a different reason to keep it. Basically, we act as if the future will look like the past.

Self-driving cars will be disruptors. They won’t really be cars. They will be a form of public transit unchained from fixed routes and designed for individuals or small groups. But, we’ll see them as “cars” because that’s what they’ll look like and that’s how we’ll be comfortable.

The internet and online shopping was a disruptor, just as were shopping centers and supermarkets. The earliest general credit card (actually a charge card) was issued in 1950 when a countable number of readers were alive. Now, we have cashier-less stores and will/might be using non-governmental cryptocurrency. On a more mundane level, one more closely relevant to the landlord-tenant relationship, the shopping center market mix is changing very rapidly. Any reader who hasn’t bought something online recently can stop reading right now and check on her or his stable. The horses may need tending.

The shopping center concept is/was pretty simple. Create a reason for customers to come and “shop.” Give land away to large department stores so they will build a store at regular intervals along your planned project’s backbone, and then connect those anchoring stores with wide corridors populated with smaller retailers. For the most part, customers attracted by the sell-everything department stores, with their broad, but shallow merchandise offering, would wander into those corridors to find narrower, but deeper choices. The developer would be “all-knowing,” and would curate the shopping experience: who could lease space, what could they sell; what couldn’t they sell; and, where would they be located. The focus was on creating a one-stop shopping destination. Of course, if you were successful in getting people to come and stay, you’d have to feed them. So, you’d lease some space to restaurants and, for those customers who don’t want to dine, you’d install a food court. Basically, developers worked to create an organism whose success depended on the symbiotic relationships among the tenants, each bringing customers to the others.

Well, times have changed. Twenty years ago (so to say), leases prohibited the sale of automobiles at the shopping center. Pick your reasons, but one had to be that people who come to shop for a car aren’t likely going to look at suits or dresses or books or jewelry during that visit. Now, an electric car seller has mall “stores.” Those stores are there because of the “traffic” at those malls, but the traffic at those malls isn’t because of a car showroom. What is more, earlier this year, it was reported that 78% of that tenant’s latest model sales were done online. [What does that do the percentage rent model?]

Research is showing that the retailer with the highest sales per square foot performance does not generate business for neighboring tenants. High-end jewelry stores have very high sales per square foot performance as well, and they don’t sell a lot of “socks” for the footwear store down the corridor or walkway. These are destination stores, ones for which a customer makes a special, single-purpose trip. Though it isn’t a solid conclusion, there is evidence that shopping center foot traffic is falling, especially within department-store anchored centers. Can landlords and tenants do nothing and take the chance the trend being reported is “for real”?

So, what needs to be done? Landlords need to treat their tenants like adults, not like children as they have in the past. Tenants need to build a relationship of trust with their landlords. The two need to develop a genuine working partnership. Yes, each has its own self-interest, but their common interests are much more significant. Each needs to give up demands for “control.” Large shopping centers have long been populated with chain stores, and one would have to be Rip Van Winkle to not have noticed. So, landlords, there are innovative retailers and would-be retailers out there with online shopping resistant businesses, ones that would give customers a reason to travel to a shopping center, even if you need to give then a bargain rent. These are also destination retailers and their customers would be exposed to other tenants’ wares.

There are merchandise categories less susceptible to online competition, the ones where “curation” makes a difference. Jewelry is such a category. Fashion (not just clothing) is another. Shopping centers replaced downtown shopping, either as leaders or in response to the move to the suburbs. Yet, certain urban marketplaces survived; areas overflowing with a single kind of retailer – specialty products, textiles, fashion, jewelry, etc. The traditional shopping center avoided this model. In many categories, developers and their tenants built environments of one category-one seller. Perhaps that approach, still taking place, resembles requiring driver’s licenses for people who do not drive.

Our industry has turned to non-retail uses for rental income and secondarily for traffic building, though we grant that few innovative ones give at least equal weight to each goal. We’ve seen an incursion of personal service businesses, like medical providers, even in large malls. But, these are almost always located at a property’s fringes, almost as if we are ashamed to have them there. In some places, you can find a motor vehicle department office in a hidden, remote location. People “have to” come to these places. These are businesses where people need to bring their bodies. Why are they hidden in a mall? Why aren’t they in the middle, so that their “customers” have to pass lots of stores while going to and from the doctor, etc.? We think it is because these uses weren’t traditional “retail.” Yes, they represent some challenges, but they also represent an opportunity.

Let’s think about today’s airports or, as we’ll describe them, shopping malls with gate areas. As we understand it, this complete changeover in how space at airports is being used can be attributed to a single company, perhaps in Pittsburgh. Now, not only can we buy way-overpriced snacks and water at an airport, but we can (and do) shop at well-known luxury brand stores. You can’t fly online. You have to go to the airport. Hence, these stores can solicit business from a captive collection of prospective customers.

Landlords – Tenants, and those who do their “work,” it’s time to use a little zero-based thinking. It’s time to look at today’s challenges anew, not merely as incremental changes from yesterday. Self-driving cars aren’t cars. They are a new “animal.” Make the rules based on what they are; don’t make “what they are” adapt to the existing rules. Brick and mortar retail is being challenged by disruptors. Why can’t landlords and tenants, working together finally, become a disruptor industry? To do that, we need to ask ourselves: “Why do we have these rules? Are they still relevant? Why is this in our leases? Why is this in our policies?” If we aren’t happy with the answers we find, or if we can’t find a satisfactory answer, let’s not just “tweak” our clauses or our thinking. Let’s start all over and design our leases and policies for the future, not just put a bandage over what is broken.

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Comments

  1. In 1974, when I started out as a shopping center leasing agent, the era of enclosed mall shopping centers was in its infancy. A lot of water has passed under the bridge in the ensuing 45 years and your recitation of the evolution accurately reflects much of what has occurred. Developing and maintaining appropriate tenant mix has always been at the forefront of ongoing concerns for retail developers and landlords in order that they be able to maximize the revenue-generating potential of their properties. And now, with the advent of free delivery online shopping and other new lifestyle and consumer behavior dynamics evolving at an ever-increasing rate, establishing a proper balance between long term occupancy security and flexibility in leases, for both landlords and tenants, is a delicate dance with no discernible lines delineating the edge of the dance floor. Thus, with such wild swings in shopping center occupancy trends – traditional department stores closing, self-driving vehicle stores emerging, making lease commitments that are too long – or too short – may be substantially disruptive to long term planning for players on both sides of the occupancy fence.

    As for service businesses, most landlords relegate these uses to fringe areas or entrance corridors or other out of the flow locations for three reasons among others; those users often cannot afford the high-priced space on the main mall that many merchandisers can afford via percentage rent arrangements (most service businesses do not operate cash registers that track sales for percentage rent reporting purposes), they are not sexy looking uses that blend well visually with sexy merchandisers on the main mall and, as few of us go to the motor vehicle registry or to the dentist more than once or twice a year, they contribute far less traffic than desired to the main mall tenants hoping to benefit from that traffic synergy. Thus, as destination players, they are happy to populate these less than top line, close to the door for quick in and out locations at more modest rental rates and the developers are thrilled to have someone lease these less than ideal vacancies.

  2. William Serwer says:

    This was a superb post and reminder for continuous improvement. But it will take the landlord and lender interests, including mortgage brokers, private equity, and institutional investment community, to get on board. But great forward thinking, so well done.

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