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OP-ED: A Retail Landscape in Flux, and Where it May Be Heading

Daily Journal of Commerce
September 15, 2017

Overview

You’ve heard it before: retail is dying. To a certain extent, it’s true. Amazon has forced numerous stores to pack up and close the shutters. Bookstores were the first victims (but not our beloved Powell’s, thankfully) because their inventories consist entirely of fungible goods. J.C. Penney, Gap, Sears, Kmart and Macy’s are just a few of the retailers that this year have announced major store closures, some in the Portland market. Other retailers will surely follow. But like most macro real estate trends, the death of brick-and-mortar retail stores will be gradual. Comebacks and innovative strategies will be developed and executed to cushion a crash landing. The purpose of this article is twofold: 

  • To explore what the current Portland retail landscape looks like, seen through the lens
    of a third-year commercial transactional real estate attorney (try saying that three times
    fast), and
  • To predict what landlords will do to entice service retail tenants into their buildings.

The Portland retail landscape

What happens when retail stores located in large shopping centers (or developments) are
forced to close their doors and vacate their spaces? Landlords need to find replacement
tenants. In some areas of Portland, this is happening right now. The difficulty in finding a
replacement tenant lies foremost in co-tenancy agreements. Most sizable tenants – or those with bargaining power – usually have provisions in their leases that prevent the landlord from renting space to certain types of tenants. Most retailers want other retailers in the shopping center to sell items that are complementary to their own offerings. Customers usually prefer to shop at places where they can purchase more than one item on their list. So retail tenants know it’s easier (and more cost-efficient) to lure customers to their stores if customers are already shopping in the area.

Given this context, the problem is clear: if retail tenants are going out of business because
they’re forced to compete with Amazon, and if most existing shopping center leases only allow for other retail-focused tenants who are also going out of business, who is going to fill the empty space? The logical answer is service retail tenants (i.e., hair salons, dentist offices, restaurants, interior design offices, title companies, etc.). These service retail tenants provide services that Amazon does not, and therefore are not as susceptible to the current trends affecting more traditional retail stores.

But what appears to be an easy solution is functionally more difficult to implement. The
problem is that most anchor tenants (think Target) don’t want service retail tenants occupying space in shopping centers because they come with intensive parking requirements and don’t sell complementary goods.

To protect their interests, bigger tenants bargain for provisions in their leases that deter
landlords from renting space to service-oriented retail tenants. Leases will typically provide that in the event landlords rent space to service retail tenants, either the anchor tenants’ rent will be cut in half or they can terminate the lease after 12, six or sometimes three months. Given the choice between filling a small, vacant space with a service retail tenant or losing an anchor tenant, landlords will likely side with the tenant that helps keep the lights on.

Going forward

If brick-and-mortar retail is to have any hope of survival, it must adapt. Moreover, landlords (and sometimes developers) must rethink how they convince tenants to lease space. One thing landlords can do is to change the way they draft (or have their lawyers draft) operating and easement agreements (OEAs) or reciprocal easement agreements (REAs).

OEAs and REAs are documents that set forth rights and obligations between landlords (or
owners) and tenants. Most of these documents contain provisions that restrict landlords from leasing space to more service-oriented retail tenants. But in order to adapt to the current changing landscape, landlords should draft their OEAs and REAs to be more flexible. The goal should be to attract the tenants who are going to be around in the next five to 10 years. This approach has its drawbacks (e.g., where are people going to park?), but the market position that discourages service retail tenants will only accelerate the current trend.

Changing the status quo, however, will require an understanding by the larger retailers that it is in their best interest to loosen restrictions. Generally speaking, a fully leased building is good for everyone. More tenants equals more customers; more customers equals more money. Everyone is happy. But large tenants (this time, think Starbucks) aren’t exactly lining up to give up their bargaining power to ensure a shopping center is fully leased. Although they would like to see 100 percent occupancy, most of the larger tenants are able to negotiate provisions in their leases that provide for an abatement of rent if the shopping center is not fully leased. In some respects, it’s a win-win in either situation.

Like anything, though, bargaining power will shift if the market demands it. Adaptation is a pillar of the real estate industry. Property owners will always strive to find the highest and best uses for their properties. Amazon is having its moment in the sun, but there’s room for service retail tenants too, if everyone can play nice.

Column first appeared in the Daily Journal of Commerce on September 15, 2017.

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